0
$\begingroup$

When the economy of a government is facing a deficit, why can't the government just increase the taxes to pay for its expenses? I've read that it should rather borrow money, because increasing the taxes would not solve the problem.

$\endgroup$
4
$\begingroup$

Firstly, a fiscal deficit is not very surprising. Governments normally want to keep its stock of liabilities (government-issued money and bonds) at least stable as a percentage of GDP. (This provides safe assets for the private sector.) Most economies normally have nominal GDP growing in steady state. The implication is that a steady state deficit is needed to grow government liabilities in line with nominal GDP.

If the deficit is larger than that steady state level, the debt/GDP ratio will rise, which is a concern for many people. The issue with rasing taxes to control this is that under any Keynesian model, the tax hike will reduce growth. This is unwelcome if the reason for the deficit was that growth was low.

Note that this is a politically controversial topic, so I just outlined the Keynesian objection (which is fairly standard), but I would note that not every economist would agree with the Keynesian assessment. There was a large debate about austerity policies (attempting to cut the deficit via cutting government spending) after the Financial Crisis. You could probably look up questions about austerity policies to get more information.

$\endgroup$
  • $\begingroup$ To add one real world comment, tax hikes are disliked by the voters and politicians who support them may not get re-elected. $\endgroup$ – zeta-band Jan 11 at 19:57
  • $\begingroup$ In addition, tax changes requiere the passing of laws, a usually slow process. Borrowing, in the other hand, is fast and simple (governments issue debt weekly or, at least, monthly). $\endgroup$ – Patricio Jan 14 at 8:00

Your Answer

By clicking "Post Your Answer", you acknowledge that you have read our updated terms of service, privacy policy and cookie policy, and that your continued use of the website is subject to these policies.

Not the answer you're looking for? Browse other questions tagged or ask your own question.