Phenomenon of National Debt

National Debt

Discussion

When the government runs fiscal deficits, it has to borrow money to compensate the difference and drive capital investments. Besides, the government has to cater for top expenses such as health care programs, defense budget expenses as well as social security programs (Sexton, 2012). Nevertheless, the national debt is projected to increase as the “baby boomer” generation moves towards retirement. This is because there will be a greater demand for resources such as social security and Medicare. National debt is a national security issue because a country that defaults on its debt service obligation results in losing its social, economic and political power (Siddiqui, 2011). Therefore, the importance of national debt implies that it is vital to perform the evaluation appropriately.

The national debt affects individuals as a result of the ramifications posited by long-run costs of high national debt. For instance, a raise in national debt has an impact of increasing national debt per capita (Lipsey & Chrystal, 2015). However, the government resorts to increasing the yield on treasury securities with an aim of attracting new investors. As a result, more tax revenue is paid out as interest on national debt and this reduces the amount of financial resources that can be spent on other government initiatives (Sexton, 2012). Such a shift in expenditures will subject citizens to lower standards of living. The other aspect to consider is that offering a higher rate on treasury securities will affect the dynamics of how corporations operate. This is because the corporations will be perceived as riskier ones and might trigger an increase in the newly issued bonds.

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Subsequently, the corporations will have to raise the prices of goods and services so as to address the debt service obligation: this leads to inflation. In addition, a high yield on treasury securities will also affect the cost of borrowing money. This is due to the strong correlation between the yield offered on treasury securities, short-term interest rate set by the Federal Reserve and the cost of money especially in mortgage lending market (Siddiqui, 2011). Moreover, an increase in the yield on treasury securities makes some risky investments to lose their appeal. An example is the corporate debt and equity investments. This can be attributed to the fact that corporations will not be in a position to generate sufficient pre-tax income, which makes it easier to offer sufficient risk premiums on bonds and stock dividends. In fact, this is the essence of the crowding out effect.

It is possible to reduce the national debt through mechanisms such as cutting spending, monetization or restructuring of the debt. A reduction in spending eliminates budget deficit through personal tax increases or spending cuts by decreasing in transfer payments (Siddiqui, 2011). In regard to personal tax, consumers reduce their spending with an increase in tax. In fact, when taxes on specific products are increased, consumers resort to substitutes that are available at a cheaper price (Lipsey & Chrystal, 2015). An increase in personal tax also reduces the disposable income, which implies that consumers will only have to spend money on essentials thus pushing in the aggregate demand curve (Sexton, 2012). An increase in personal tax also leads to a reduction in spending and poor standards of living because consumers cannot spend additional amounts within their disposal. This can create unemployment and make it harder to access quality products and services.

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The other solution to decrease the budget deficit is to reduce transfer payments and discretionary spending. In this respect, the payments are not part of a national income as they are a redistribution of income in the market system (Lipsey & Chrystal, 2015). They do not involve an exchange of goods and services. A reduction in transfer payments means that the recipient of such payments will experience a reduction in consumption. In fact, the reduction reduces the disposable income thus leading to less aggregate production and employment. This will eventually reduce the inflationary pressure. However, the reduction of transfer payments has unintended consequences such as reduced output and undesirable behavior (Lipsey & Chrystal, 2015). This might dull work incentives and alter the work behavior of employees. Nevertheless, transfer payments can lead to the abolishment of productivity gains because the payments denote a sense of dependency on the government.

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Conclusion

National debt is an imperative public policy issue and can influence the long-term growth and prosperity of a country. The government can manage the national debt by reducing the deficit that makes it resort to borrowing. It is possible to achieve this through an increase in personal taxes or a reduction in transfer payments. An increase in tax ultimately reduces consumer spending because people prefer to save as they wait for the government to embrace a tax reduction strategy. However, the best strategy to be adopted in the reduction of national debt has always been an issue in the Congress. For an on-going deficit, the long-term solution would be focusing on growing the economy as this will increase tax revenue.

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