How Governments Are Always Short Of $$$$; Don’t Follow Their Example

If you get a monthly allowance and two weeks into the month you have finished this, what options would you have (assuming you can’t work because you are too busy with school/college)?

You can (1) stop spending, (2) borrow money from friends or (3) ask your parents for more money. Given that option 1 seems implausible and option 3 will not go down well, you would most likely revert to borrowing. Spending more money than you have once or maybe twice, could be solved by asking for a temporary loan. But being structurally short of cash, because what comes in is never enough to cover the outgoings, means you will need to borrow more and more money all the time. This, of course, would be unsustainable. That is, unless you are a government.

Governments' Cash-flow

Governments have as their only source of income the total of the various taxes paid by corporations and individuals. It is then the task of the Government’s Treasury to estimate the total of tax revenues coming in each year and to decide how this money, much like your allowance, will or can be spend. The outgoing expenses mainly cover education, healthcare, social care, defence, the salaries of public sector workers and infrastructure and naturally every one of these sectors wants a fair share of the pie.

In the UK, the overview of the nation’s cash-ins and cash-outs is presented in the Autumn Budget each year. The UK’s Chancellor of the Exchequer – currently Rishi Sunak – swings the famous red leather case in front of the press and will then reveal who gets what, at least in the budget, and all the rows should neatly line up. But mostly they don’t. Why not?

Spending always more

Governments are often, if not always, short of cash. They overspent and hence they have a budget deficit, or shortfall. Possible reasons for this could be the fact that - on the income side - taxes paid by corporations, the biggest contributors to the Treasury, are declining, because manufacturing is moved offshore, or taxes are paid in more friendly tax regimes. Taxes paid by individuals could be less because people find clever ways to minimise it or simply have less tax to pay because they work less, are less productive or unemployed. For example, if the unemployment rate rises unexpectedly (aka it was not foreseen in the budget) the Treasury will receive less income tax and pay out more unemployment benefits. But the key reason for the budget shortfall is that governments, in most countries, spend more than they receive.

How to fund the gap

The deficit is ‘managed’ by borrowing and partially by higher taxes. But people do not like paying more tax, so governments borrow. A lot. The UK Government borrows about £300 billion a year and currently has a total debt of £2.2 trillion, about 98% of GDP. That seems small potatoes in comparison to the US, which needs to borrow about $3.1 trillion each year to cover the lack of income and now has a total debt of almost $30 trillion or 137% of GDP. To put this into context, even during the (US) War on Terror, the 2008 Financial Crisis and its aftermath, the US total debt did not exceed 82% of GDP.

Governments find funding by selling loans – to us

How do Governments worldwide borrow? They issue loans, called bonds. Bonds are bought by banks, investment- and pension funds and individual investors. In return for lending money to the government, the buyer/bondholder gets a periodic interest payment on this bond, until it reaches maturity when the entire loan/bond is repaid. Bonds can have maturities from 1 to 30 years, or occasionally even longer.

Interest rates, or the lack of them

Government borrowing today is higher than at any time in recent decades and the interest payments on these loans are burdensome enough on their own. It may be no surprise then that interest rates are and remain so low? The steady decrease of interest rates over the last 20 years has come in quite timely and has made borrowing cheap. Any upward change in interest rates would really hurt governments as the higher interest payments on the loans would have to be covered by even more borrowing or higher taxes. For context, the UK’s total debt spiralled up to about 80% of GDP in 2008/09 and interest rates, during this year of the financial crisis, were adjusted downwards (in one single year) from 5.00% to 0.50%, a conveniently attractive rate to borrow at.

Comparing all this to your allowance; imagine you would borrow the same amount of your allowance every month from a friend and by the end of the first year you would owe your (very accommodating) friend 12 times the amount of your allowance PLUS interest. You very quickly realise you are unable to pay this money back and that you could end up in a perpetual borrowing cycle. Managing your budget and not overspending your allowance now and future salary later is a key skill to have. Because that way, unlike many governments, you remain in control.

Recommended links:

https://commonslibrary.parliament.uk/research-briefings/cbp-8513/

https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1029973/Budget_AB2021_Print.pdf

https://www.talksforteens.com/finance/gdp-and-how-taxes-make-you-happy

https://www.talksforteens.com/finance/are-zero-rates-an-economys-best-friend

https://www.bbc.co.uk/news/world-us-canada-58820071