Maroula KhraicheBelieve it or not, government debt is not always a bad thing. In fact, it is often quite the opposite. Just as private citizens and businesses often have perfectly legitimate reasons to borrow in order to finance projects that will increase their future earnings, so it is with governments. Just as individuals may need temporary loans to finance their education or to deal with unanticipated emergencies like car accidents or lawsuits, governments may need temporary deficit spending to fund better education systems or to offset large-scale shocks like natural disasters or financial crises.

illustration of a person carrying a lot of debtThe more specific question of just which projects are “debt-worthy” is more contentious. Should the government bail out big banks when they are at risk of folding? Do we need an economic stimulus package to reduce unemployment? Exactly how much should be spent on public services? Such questions all involve at least some subjective value judgments, so there are no perfect answers. But nevertheless, that does not mean that there are no projects worthy of some deficit spending in order to yield future returns.

A more relevant question when it comes to government debt is: How much is too much? As certain European countries are recently making clear, deficit spending cannot go on forever. But all economies are different.

Just like individuals, countries differ both in terms of their access to credit and in terms of their ability to repay. Generally, an economy that is perceived as a good credit risk is able to borrow at lower interest rates and therefore sustain higher debt levels. The U.S., having a history of stable growth that is rather impressive for a developed economy (as well as other advantages such as the dollar’s status as a reserve currency) is able to borrow on quite favorable terms. Greece, on the other hand, which has a rather poor growth record and which is hindered by its inability to devalue its currency due to its inclusion in the euro area, is not able to borrow as favorably.

The case of Greece also illustrates how quickly debt can spiral out of control. Since the amount of interest a country must pay on its debt adds to the burden itself, if creditors perceive an increase in a country’s risk and begin to demand higher interest rates, a feedback loop quickly develops.

The U.S. is currently nowhere near Greek levels of risk in terms of its debt load, but nonetheless it is prudent to steer clear of a similar tipping point. In a sense, doing so is quite simple. The government must tax more or spend less or both.

Economic theory and evidence can help guide policymakers to some extent in choosing a combination of tax and spending changes that will do the least to hinder economic growth (and hopefully even improve it). Ultimately, however, the course of action will depend in large part on subjective opinions and political feasibility. All the commotion over increasing the debt ceiling throughout the summer of 2011 was not because it is not possible to reduce our debt. It was because doing so will inevitably mean someone paying more or receiving less, and it is difficult to decide just who that should be.

So it is not really an issue whether or not government debt can be worthwhile. Nor is it an issue, in the case of the U.S., that our debt level can’t be reduced. The fundamental issue is that making the subjective decisions to accumulate debt is politically easier than the subjective decisions to figure out who should pay for it.