Causes and effects of deficit spending

As we know, the main sources of government revenue are taxes, fees, prices, special assessments, tax rates, donations, etc. etc. When during a certain period government expenditure exceeds government revenue and the deficit is covered by borrowing, it is called deficit financing or income-generating financing . In order to achieve significant expansion effects, a public investment program should therefore be financed by borrowing rather than taxes. This type of borrowing or lending is popularly known as deficit spending.

Deficit spending is said to have been practiced when the government employs any or all of the methods below:

(a) The government draws on past cash balances.

(b) The government borrows from the central bank against government securities.

(c) The state creates money by printing paper money and thus covers expenditure through revenue.

(d) Government borrows from outside.

Deficit spending was seen as a very dangerous weapon by classical economists. However, modern economists tend and recommend using them to accelerate economic development and achieve a high level of employment in the country.

The problem to be solved here is:

(i) Whether income-generating financing should be used to increase effective aggregate demand.

(ii) If deficit spending is desirable to ensure high levels of employment, to what extent should it be implemented?

(iii) What are its good and bad effects?

Deficit spending is practiced by both advanced and underdeveloped countries. The advanced countries use it as a tool to increase effective demand, while the underdeveloped countries use it to increase the rate of capital formation.

The scope of deficit spending to accelerate economic growth in a backward economy is very bright as they are caught in a vicious cycle of underdevelopment. They use funds for investments when the country’s resources are insufficient to initiate the start-up processes. This creates the need for deficit spending.

The underdeveloped countries face the following problems:

(i) Population growth is faster than economic development.

(ii) State revenues from taxes, levies, etc. are not sufficient to provide full employment for the labor force.

(iii) Per capita income is extremely low, as is the ability to save.

(iv) Foreign loans for development purposes are not subject to change and are not available in the desired amount.

(v) There is a shortage of capital in the country.

(vi) People lack initiative and entrepreneurial skills.

(vii) People tend to be extravagant and there is less voluntary saving.

(viii) A larger part of the population lives in villages and fights for their lot.

(ix) The government cannot arouse popular anger by raising tax rates beyond a certain limit. It also cannot levy additional taxes for the same reason.

(x) So there is too much tax evasion.

Under the above conditions, the reader can easily imagine what a government of the backward country faces. Still no government wants to be a silent spectator and wish that people’s living standards should rise in the shortest possible time. It will try to find money out of the blue if necessary for the spread of the country’s economic development. This is where deficit financing comes in handy. The state uses this tool to lift the economy out of the depression and accelerate the country’s economic development. However, if the state can increase the volume of resources through tax rate increases, additional taxes or the mobilization of expanded savings, it is unwilling to use deficit spending because it is a very delicate tool.