CHAPTER - II

THEORETICAL ASPECTS OF PUBLIC DEBT

2.1 CLASSICAL THEORY OF PUBLIC DEBT

2.2 NEO-CLASSICAL THEORY OF PUBLIC DEBT

2.3 CRITICAL REVIEW OF CLASSICAL AND NEO-CLASSICAL

REVIEW

2.4 MODERN THEORY OF PUBLIC DEBT

2.5 KEYNESION THEORY OF PUBLIC DEBT

2.6 POST –KEYNESIAN THEORIES OF PUBLIC DEBT

2.7 DEBT SUSTAINABILITY ANALYSIS

2.8 CRITERION OF DEBT SUSTAINABILITY

2.9 BURDEN OF PUBLIC DEBT

2.10 CLASSICAL VIEW ON THE BURDEN OF PUBLIC DEBT

2.11 MODERN VIEWS ON THE BURDEN OF PUBLIC DEBT

2.12 MODIGLIANI’S BURDEN THESIS

2.13 MUSGRAVE ANALYSIS ON THE BURDEN OF PUBLIC DEBT

2.14 CONCLUSIONS REGARDING BURDEN OF PUBLIC DEBT

2.15 CONCLUSIONS

2.16 REFERENCES
 15

CHAPTER –II

THEORETICAL ASPECTS OF PUBLIC DEBT

2.1 CLASSICAL THEORY OF PUBLIC DEBT

The Economists favoured public debt in the 18th century when there was
an impact of Mercantilist doctrine. But in the 19th century, the role of the state
was restricted within the limit of some minimum functions. This was the view of
classical economists who believed in “Laissez Faire” policy. These economists
had the view that the State functions should minimum and the government had to
maintain only internal law and order, defence from external aggression and look
after some public works. They believed that full employment existing in the
economy and there is a perfect competition and mobility of factors for production
in the market. They had more belief in individualism and felt that self-interest
leads to national interest. There is no need of government intervention in the
smooth going economic activities and if any calamity befalls it will brought to
equilibrium point automatically. When the government is performing minimum
functions then there arises no question of huge public expenditure and for that no
need of large public revenue. Further government did not require raising funds in
the form of public debt also. In addition to this, they said that the State
Government expenditure is wasteful and unproductive. As the supply of money is
fixed, any amount that is transferred to the government will be at the cost of the
private employment and private expenditure and the funds so borrowed will be
withdrawn from the productive uses and will be put into unproductive channels.

Thus, public debt will inflict unnecessary burden on the shoulders of the
community.1 Adam Smith’s “Wealth and Nations” attacked the fundamental roots
of mercantilism, and was in a large degree an attack on the nationalism and state
regulation in all spheres of life, which characterized the mercantilist system.
This reaction against the mercantilist system produced the ‘Laissez-Faire’
determined scope of State Government activity.

Adam Smith’s approaches on the appropriate role of the State

Government in the economic affairs can be inferred from the economic principles
16

that he propounded in his writing; ‘but Smith did not leave them to be implied
and stated them explicitly. Book IV of the ‘An Enquiry into the Nature and
Causes of the Wealth of Nations’ wealth with the System of Political Economy’
and most of this book discussed the mercantile system. In the last chapter,
he stated his views on the functions of the State. To quote him-“All systems
either of preference or of restraints, therefore, being thus completely taken away,
the obvious and simple system of natural liberty establishers itself on its own
accord's Everyman as long as he does not violate the laws of justice is left
perfectly free to pursue his own interest his own way to bring both his industry
capital into competition with those of any other man, or order of men.
The sovereign is completely discharged from a duty in the attempting to perform
which he must always he exposed to innumerable delusions and for the proper
performance of which no human wisdom or knowledge could even be sufficient;
the duty of superintending the industry of private people, and of directing it
towards the employments, most suitable to the interest of the society. According
to the system of natural liberty, the sovereign has only three duties to attend to;
three duties of greater importance indeed, but plain and intelligible to common
understanding, i) the duty of protecting as far as possible, every member of the
society from the injustice or oppression of every other member of its, or the duty
of establishing an exacting and maintaining certain public works and certain
public institutions which it can never be for the interest of any individual,
or small number of individuals, to erect and maintain, because the profit could
never repay it to a great society .3 Regarding the last category, Smith said that the
post office was perhaps the only mercantile project, which was successfully
managed. He also advocated that the government should provide for the
education of the common people and the district schools should be partly and not
wholly supporter by the state. Smith also suggested that many public works such
as roads, and to a great extent, education should be self-sustaining, supported by
those who use them, in more or less the proportion of the use they make of them.
Among the State Government services, which Smith does not believe, can be
conveniently paid for by those directly concerned is the administration of justice,
since obvious abuses can result from such financial arrangements.4
 17

J. B. Say in his own works considers the functions of State Government

in connection with his analysis of public finance. Unlike Smith, he goes into
some details on the more general aspects of the problem and justifies and
highlights the benefits of public works, and communications. To understand
public expenditure it is well to be acquainted with the needs of society.
Independent of the needs felt by individuals and families which give rise to
private consumption, men in society have wants in common which can only be
satisfied by the co-operative effort of all the individuals composing it (society).
Now this co-operative effort can only be obtained by an institution, which can
command the obedience of all within the limits permitted by the form of State
Government.5 Hence he comes close to the modern argument based on the
divergence between private and social gains. J. B. Say propounded the famous
‘Laws of Market’, which stated that ‘Supply Creates its Own Demand’…and that
the whole economy was self-adjusting. Hence minimum of state action and
government intervention was suggested.

J. B. Say also aggressively opposed public debt. For him, “There is a

remarkable distinction between an individual borrower and a borrowing
government, the former borrows capital for the purpose of the barren
consumption and expenditure.”6 And he further conceived that, “Public
borrowing is not only unproductive because the capital is consumed and lost,
but in addition, the nation is burdened by the annual interest payment. It cannot
be argued that the annual circulation of interest payment is a net addition to
capital.”7

David Ricardo referred to public debt as…one of the most terrible sources
which was even invented to afflict a nation.8 Ricardo made important
modifications in the arguments of Adam Smith and J. B. Say pointed out that
important burden of national debt was in the annual interest transfer, but in the
lost of original capital. To quote him “when for the expenses of the years was,
twenty million are raised by means of loans, it is twenty million which are
withdrawn from the productive capital of the nation. The million per annum
which is raised by taxes to pay interest of this ban is merely transferred from
those who pay it to those who receive it, from the contributor of the tax to the
18

natural creditor. The real expense in the twenty million, and not the interest
which must be paid for it”.9 He was of the view that presence of a debt did not
affect the nation ability to pay taxes, hence no great economic advantage could be
achieved by retiring the debt.10 Levying of taxes to pay, the interest obligation
may lead to capital movements to other countries.

J. S. Mill’s theory of State actions is in fact an application of his

utilitarianism which is identical to that of J. Bentham-“the admitted functions of
State Government enhance a much wide field then can easily be included within
the ring fence of any restrictive definition, and it is hardly possible to find any
ground of Justification, common to them all except the comprehensive one of
general expediency.11 This statement is supplemented by a declaration in favour
of Laissez-Faire “Letting alone in short should be the general practice, every
departure from it, unless required by some great good, is a certain evil.
Considering the economic functions of state in the concluding book of his
“Principles of Political Economy”, Mill mentioned what become famous
exceptions to the general rule of ‘Laissez-Faire’ i. e. that there is a case in
economic theory for the protection of infant industries by an import tariff.
The only case in which, on mere principles of political economy, protection
duties can be defensible, is when they are imposed temporarily(especially in a
young and rising nation) in hope of naturalizing on foreign industry , in itself
perfectly suitable to the circumstances of the country”. In the same book,
Mill studied the general functions of State Government and stated certain reasons
for limiting its roles-:

1. There is a part of the life of every person who has came to years of
discretion within which the individuality of that person ought to
reign uncontrolled either by any other individual or by the public
collectively.

2. Every increase of the functions devolving on the government is an

increase of its power; both in the form of authority and still more,
in the indirect form of influence.
 19

3. The great majority of things are worse done by governments than

they would be done by private individuals who are interested in
them.

It would be wrong to classify the classical economists as die-hard

defenders of ‘laissez-faire’. Their attitude towards ‘laissez-faire’ was relative and
conditional. As J. S. Mill put it “the admitted functions of state government
enhance a much wider field than can easily be included within the ring-fence of
any restrictive definition and ….It is hardly possible to find any ground or
justification common to them all, except the comprehensive one of general
expediency”.12 Limit of State activity varied between countries and stages of
development. Bentham(followed by J. S. Mill) distinguished between Agenda
(where the State should act) Sponti Acta (phenomena developed naturally by
society) and Non-agenda (area of state government inaction).

Classical Economists also considered public health, regulation a function

of state government, with growth of urbanization they stressed public health
regulations and check of adulteration. N. S. Senior even envisaged public
provision for medical treatment.

Classical Economists viewed a number of areas where state intervention

was definitely undesirable–notably in price fixation, regulation of industries,
taxation of food commodities, restriction on monopolies etc.13

In his book, ‘Treatise of Taxes and Contributions’, Sir William Petty

beings by giving a list of the functions of the State which call for public
expenditure, a list which was later to reappear with slight changes in many of the
classical writing. In the list of State Government functions he includes military
and defence functions, the administration of justice, religious and other
education, care of the impoverished the in-capacitated and the unemployed and
the construction and maintenance of roads, bridges, navigable rivers, ports etc.
Which are conducive to the general welfare of the community as a whole.14

National debt according to T. R. Malthus was not evil which it was

generally supposed to be. He was of vies that those who live on the interest from
the national debt “….Contribute powerfully to distribution and demand…they
ensure that effective consumption which is necessary to give the proper stimulus
20

to production”15 According to him debt once created was not a great evil.
But later on the modified he views to bring them closer to that of the classical.
There are after all evils in the debt. The taxation which is required to meet the
interest payments may be harmful; people thing that debt should be paid off,
so the interest on it is always to some degree. “In sense”, the presence of the debt
aggravated the evils arising from changes in the value of money.16

The classical theory is criticized mainly on two grounds. Firstly, every

government expenditure is not always unproductive, hence public borrowing may
not be always burden upon the economy and secondly, the traditional view
regarding the shifting of debt, is not correct. The real burden must be borne in the
period in which public expenditure has been incurred through government
borrowing program because resources are not withdrawn from private use and put
into public projects only in this period. There is no burden of the basic burden to
the future generation. Future generation not only inherits liabilities of the
payment of interest and principal from the present generation but also inherits
assets in the form of the right of receiving the interest and principal on the
payment side along with interest and principal on the receipts side belong to the
same generation; there is no inter-generation transfer but a transfer within the
same generation.

2.2 NEO-CLASSICAL THEORY OF PUBLIC DEBT

Neo-Classical Economists was an extension of the classical stream of

through, broadly indentified the approach taken by the new school. An economist
was visualized as a study of the allocation resources to satisfy human wants.
Another significant development in the neo-classical economists was the
emergence of the welfare theory and it applied utilitarian ideas over the entire
range of functions.

A. C. Pigou is particularly identified with welfare theory. In his

‘Economics is Welfare’ he said that the main motive of economic study is to help
social improvement.17 The concept of ‘Ideal Output’ was central. Pigou defined it
as that composition of ‘production such that no alternative output which could be
obtained by means of re-allocation among the various industries of the
economy’s resource would by itself achieve ideal output. If and only when
 21

a private market relationship departs from ‘ideal output’, then state intervention
was justified.

As regards State functions the basis ideology of the neo-classical was that
the economic system functions in response to the instructions of the market the
ultimately the consumer. If this response is in adequate or imperfect then the state
should amend or supplement the response in the better interests of the community
at large. The States role was essentially supplementary and regulatory.
Neo-classical had a strong adverse attitude towards tariffs, price supports, and
governmental assistances. They felt that the services of the State though of great
importance for economic progress did not help development of industries.
They adopted the principle of State ‘Neutrality’. It was contended that the State
should refrain from distributing the pattern of resource allocation determined by
private market. Private market misallocation of economic resources only
resources only justified State intervention such as when markets were organized
on monopolistic rather than competitive lines, then there would be misallocation.
Hence a tax on monopoly by State was favored.

1. In the case of externalities, state subsidies, or even public

ownership was favored e.g. education and transport facilities.

2. Public goods such as roads, telecommunications, etc, should be

State provided.

2.3 CRITICAL REVIEW OF CLASSICAL AND NEO-CLASSICAL

REVIEW

Both the streams of thought believed in the ‘laissez-faire’ based non-inter-

venations state policy- Belief in the self adjusting mechanism of the free market
system led them to limit the role of state activity to “police state” or regulatory
functions such as defense of the country, maintenance of internal law and order
through civil and police administration and dispensation of justice and
contractual obligations. They also, on a limited scale supported public works
which had welfare effects and beneficial effects on private industry, trade and
commerce. Any other function relating to industry trade and commerce
performed by the state government was considered an encroachment in private
initiative and enterprises. It was also uncalled for owing to the possibility of full
22

employment through free market forces and inefficient, for the State government
as a corporate body lacked stake in the economic functions unlike the private
persons.

2.4 MODERN THEORY OF PUBLIC DEBT

The economic philosophy of public debt in modern finance shows

a radical departure from the “Laissez Faire” notions. This situation changed after
the Great Depression of 1930s to a great extent. The classical theory of public
debt had absolutely collapsed which had taken for granted full employment and
unproductiveness of public expenditure. The classical antagonism towards public
borrowing was based on these assumptions. Those that follow Keynes take into
account the income-generating aspect of the public debt and reject any possibility
of internal debt being burden upon the community.18

2.5 KEYNESION THEORY OF PUBLIC DEBT

The Economic crisis created by the great depression of 1930’s was partly
responsible for the development for modern theory of public debt. The traditional
view that constant unbalanced budgets and rapidly rising public debt imperial the
financial stability of the nations, gradually gave way to the conception which
states that a huge public debt is a national asset rather than a liability and that
continuous deficit spending is essential to the economic property of the nations
(of public debt assumed full employment). The Keynesian attack on the classical
principles of budgeting and public finance was logical extension of the Keynesian
attack on the view that economy tends to equilibrium at full employment. Keynes
assumed that if there were unemployed resources.

Which the private sector could not employ, these resources can be put to
use by the by unbalancing the budget. Keynes held the views that increase in
public debt through the multiple effects would raise the National Income.
He linked public borrowing with deficit financing and authorized government to
borrow for all purposes so that effective demand in the economy is increased
resulting in increased employment and output. He did not draw any demarcation
between productive and unproductive expenditure as the classical. Keynes
borrowing for consumption was as desirable as borrowing for investment in
productive goods because consumption expenditure induced investment to rise.
 23

Keynesian analysis reached its culmination in A. P. Lerner’s “Functional

Finance”. This viewed government revenue and expenditure and government
debt solely as instruments for the control of community expenditure. These were
merely the tools to achieve the goal of stable employment. Taxed and expenditure
were to be increased or decreased. Safely to affect the nations rate of spending;
debt instrument were to be sold to the public to absorb their idle balances and
redeemed to increase liquidity in times of depression.

The Functional Finance theory holds that, the “Absolute size of the
National Debt does not matter at all , and that however, large the interest payment
that have to be made these do not constitute any burden upon the society as a
whole.19 The on burden thesis also gives importance to certain advantage of
public borrowing. The economic effect of public debt should be assessed in the
light of the nature of the expenditure for which debt is incurred and in terms of its
income generating potentialities. The modern theory gives importance to the net
burden of public debt. The theory further states that additional flow of income
generated by increased debt financed expenditure facilities the payment of taxes
to serve the debt. At times of unemployment, increase in public debt contributes
to current capital for nation that would otherwise have not taken place.
In addition the modern theory also states that public borrowing promotes the
development of more and more institutionalized sources of savings like Banks,
Stock and Capital Market/ Markers and Insurance Companies. Public at large
also can invest their savings in government bonds due to growth of public debt. J.
M. Buchanan called this modern theory of public debt as the “New Orthodoxy”,
which according to him is based on three basis assumptions.20

1. The creation of public debt does not involve any transfer of the
primary real burden to future generation.

2. The analogy between private debt and public debt is wrong and;

3. There is a sharp and important distinction between an internal debt

and an external debt.
24

2.6 POST –KEYNESIAN THEORIES OF PUBLIC DEBT

The Post-Keynesian theories of public debt written on the background of

huge rising public debt and the developed nation going through a phase of
inflation and price rise. Government expenditure also was rising at a rapid rate
and non-developmental component of it was quite high too; these recent theories
of public debt again revived the controversy of whether public debt is a burden
and how to measure the burden of public debt. James. M. Buchanan’s public
principles of public debt (1958), challenged the modern theories view that, public
debt is no burden on the economy and no matter how financed cannot be shifted
to future generation. Later J. E. Meade and R .A. Musgrave, too agreed to
Buchanan’s idea. Buchanan had tried to prove that in the most general case :

1. The primary real burden of a public debt is shifted to future

generation.

2. The analysis between public debt and private debt is

fundamentally correct and

3. The external debt and internal debt are fundamentally equivalent.21

1) THE BUCHANAN THESIS

The no burden thesis and the views that the primary real burden cannot be
shifted to future generations, Pigou’s thesis remained unchallenged till 1958
when it became again lively due to the publication of Buchanan’s monograph.
In his ‘Public Principles of Public Debt’, Prof. Buchanan gave his own definition
of the “Future Generation”. He takes a “Future generation as any set of
individuals living in any time period following that in which the debt is created
.The actual length of the time period per se is not relevant .If we choose an period
of one year and if we further call the year in which the borrowing operation takes
place, ‘to’, then individuals living in any one of the years, t1, t2, t3, . . . . . .tn, are
defined as living in future generations. An individual living in the living in the
year ‘to” will normally be living in the year but he is a different individual in the
two time periods….I shall not be concerned as to whether a public debt is
transferred to our children or grandchildren as such. I shall be concerned with
whether or not the debt can be postponed.”22
 25

With this concept Buchanan has tried to refute that the primary burden of
public debt cannot be shifted forward.

The ‘New Orthodoxy’ argues that the burden is borne by the generation
living at the time of the debt creation because it is the generation, which
sacrifices its goods and services and transfers the same from private employment
to the hands of the government. However Buchanan contradicts it on the ground
that the contribution to a voluntary loan involves no sacrifice. “If an individual
freely chooses to purchase a government bond, he is, presumably, moving to a
preferred position on his utility surface by so doing. He has improved,
not worsened, his lot by the transaction. This must be true for each bond
purchaser, the only individual who actually gives up a current command over
economic resources. Other individuals in the economy are presumably
unaffected, leaving aside for the moment the effects of the public spending.
Therefore, it is impossible to add up a series of zeroes and/or positive values and
arrive at a negative total. The economy, considered as the sum of the individual
economic units within it undergoes no sacrifice or burden when debt is
created.”23

Buchanan distinguishes between citizens in their role as tax payers and as

bond purchasers. He rejects the notion that the burden of state government
expenditure is borne by society. In a democratic society, individuals as tax payers
bear the cost of State government expenditure but they bear it at different times
under the two methods of finance. If the debt is issued, the obligation as tax
payers and the burden of expenditure are both shifted to future periods. Buchanan
attacks the prevailing argument that future generations bear no burden of any
public expenditure finance by debt which is incurred in the current periods
because interest receivers and tax payers are members of the same generations.
The burden or objective cost of public expenditure is the reduction in tax payers’
consumption of private goods and services. The difference in the position of the
tax payers under the two methods of finance becomes crucial. As citizens,
tax payers individually vote for the State government project and the method of
finance. They choose taxation if the burden is to be borne at once. They select
debt finance if the reduction in consumption is to be postponed. A tax payer
26

implicitly borrows the real resources from bond purchasers in the initial period in
exchange for giving them control over real resources in the future. Taxes levied
in future periods for debt servicing are not merely transfer payments bur
correspond to the bearing of the objective cost of the expenditure by tax payers
who must reduce their private consumption, when transferring purchasing power
to bond holders to compensate the latter group for the project in the initial period.
As Buchanan declares, “The tax payer in period ‘to’ does not sacrifice anything
since he had paid no tax for the wasteful project. The burden must rest; therefore,
on tax payers in future time periods and no one else. He now must reduce his real
income to transfer funds to the bond holder, and he has to productive asset in the
form of a public project to offset his genuine sacrifice. Thus, the tax payers in
future time periods, that is the future generation, bears the full primary burden of
the public debt.” In this directions he further explains, “If the debt is created for
productive public expenditure, the benefits to the future tax payers must of course
be compared with the burden so that, on balance, we may suffer a net benefit or
a net burden. But a normal procedure is to separate the two sides of the accounts
and to oppose a burden against a benefit, and this future tax a payer is the only
one to whom such burden may be attributed.” 24

In his ‘Fiscal Theory & Political Economy: Selected Essays’ he defines

burden in terms of reduction in individual utility and (utility is a function of
current consumptions and current net worth) if he knows the correct amount of
tax to pay in future for service and retire the debt, then he bears no burden
because it is merely the objective counter part of the earlier reduction in utility.
So far shifting the burden to future, there must be an uncertainty concerning
future taxes (public debt illusion). However, in his latter paper he rejects this
concept of burden. He now accepts burden or objective cost of public expenditure
to the reduction in tax payer’s consumption of private goods and services.

Buchanan’s additional thesis is that the analogy between private and

public debt is fully valid, because “Borrowing takes the place of “earning”
additional revenue through taxation for governments. Borrowing in either case is
a means of securing additional current purchasing power without undergoing
supplementary current cost. The costs of expenditures currently undertaken are
 27

effectively are shifted to future time periods. In such future periods creditors hold
a primary claim against the revenue or income of either the individual or
government.”25

Buchanan’s third proposition is that the external and internal debt is

fundamentally of the same character. He argues that in both cases, the purchase
of government securities voluntarily gives up command over current usage of
resources in exchange for a return in future period. Answering the objection that
the external debt is more burdensome, he states that the total national income
must always be larger in the external case. But he overlooks the fact that the sale
of securities to foreigners always creates some added problems.

Fallacy in Buchanan’s hypothesis is that, firstly, he does not always

define ‘real burden’ in a significant clear manner. And secondly, he defines
generations in such a manner that the same person can be considered a member of
many different generations.

2) THE BOWEN-DEVIS-KOPE THESIS

Being aware of the limitations and the drastic receptions of the thesis of
Prof. Buchanan, three economists of Princeton University, William G. Bowen,
Richard G. Davis and David H. Kopf came forward with new reasoning to
challenge the validity of the Pigou thesis. They are of the view, “If the real
burden of the debt is defined as the total amount of private consumption goods
given up by the community at the moment of the time the borrowed funds are
spent, the cost of the public project must be borne by the generation alive at the
time the borrowing occurs.” Pigou maintained that if the project is financed out
of consumption no burden will be shifted to the subsequent generations, just on
the contrary Bowen, Davis and Kopf observe that even if we suppose that bonds
are purchased out of consumption the burden will be shifted to the future
generation. Their assumptions are as follows:-

1. A full employment economy with price stability as visualized by

Buchanan.

2. First generation all of whom are 21 years old at the time of the
government’s loan expenditure say in the year Y.
28

3. After 44 years when all the members of the generation 1st are
65 years old and the rest of the community is made up of G2
whose members are all 21 years old.

4. A G3 following the same age sequence and subsequent generations

as required.

5. At the time of financing G1 purchases the bonds out of

consumption and,

6. At the time of retirement G1 sells the bonds to G2 who subscribes

out of consumption expenditure and G1 utilizes the sale proceeds
for meeting the consumption expenditure.

Their story starts with G1 on the screen in the year say Y0 purchasing
X amount of government bonds, purchasing entirely through reduction in the
consumption expenditure. Thus the consumption of G1 is reduced in the year
Y0 by X. But after 44 year i.e. in Y44, G1 sells the entire bonds to G2 and uses the
entire proceeds on consumption. Thus the consumption of G1 is not reduced.
During their lifetime the members of G1 will spend the sale proceeds,
the consumption of G2 will be reduced. It will be deferred up to another 44 years
when G2 will receive the X from G3 and spend it on their consumption;
the consumption of G3 will be reduced. The story will come to an end when the
bonds will be paid back. For this purpose additional taxes will be levied.
The generation living at that time will bear the burden of the tax; no doubt it will
be a recipient too. But the amount X that it has paid to the preceding generation
through its reduction in the consumption will be a net loss and a burden shifted
on account of borrowing. Had there been tax financing it would have not been the
case.

The analysis may be expressed as follows:

YEAR GENERATION CONSUMPTION

Y0 G1 -X
G1 +X
Y44
G2 -X
G2 +X
Y88
G3 -X
 29

It is clear that in year Y when the G1 has purchased the bonds of the value
of X, the consumption is reduced, but the consumption of every subsequent
generation is deferred by 44 years and it will continue till it is paid off. G1 simply
makes a temporary reduction in its consumption in the year actual and permanent
reduction is made by the generation surviving at the time of the final payment.
Thus to them G1 has shifted the burden to that generation.

Regarding the interest payments on the bonds Bowen, Davis and Kopf
argue that, “Interest payments on the debt repayment some burden on each and
every generation that must pay taxes to such payments.”26 As interest is a kind of
payment to compensate the preference of present consumption to future
consumption they are of the view that, “So long as people have a positive rate of
time preference they will feel that they have made a sacrifice, if they give up
a certain amount of consumption in their youth and then receive back exactly the
same amount of consumption in their old age. But if we assume that the interest
rate on the state government bonds approximates the interest payments on the
national debt, then the interest payments on the national debt serves to
compensate the owners of the debt for their willingness to forego consumption
early in life.”27

On the basis of above analysis they conclude that, “As the government
expenditure is financed entirely out of reduction in consumption, the capital
equipment remained what it would have been if the government expenditure had
not been incurred, yet G1 has shifted part of the burden to G2, G3. . . . . . Gn. party
because, “The deferment of consumption by the G1 from Y0 and Y44 is sacrifice
that G1 never recoups.”28

The entire skeleton of their analysis is based on the fact that G1 does not
impair the capital stock of the economy; G2 inherits the same stock of capital
from G1, had there been no government expenditure and no public borrowing.
But this argument is not correct if we examine it more deeply. They have
maintained that, “G1 has contributed for the purchase of bonds through their
reduction of consumption of X in Y0 year and Y44 year they would recover the
loss in consumption by spending the sale proceeds. Thus according to them
G1 has not damaged the capital stock of the economy. But this is not so.
30

It is evident from the fact that G2 compulsorily in the every year.29 But one thing
is certain. Had G1 utilized the X amount of bond in the very year Y0, had it
purchased the bonds out of saving, the capital stock inherited to G2 would have
been much smaller because X amount would not have been used in between
Y0 and Y44 for capital formation.

A bit further, to argue their case they assume that there is no overlapping
in two generations and G1 sell its bonds to G2 and so on. Thus they have coined
two impractical and unreasonable assumptions, if G2 did not buy the bonds from
G1 but it is inherited from them, the diminution in the consumption in the year
Y0 would be borne by G1 and not by the subsequent generations. Not only this,
in their case, it is also necessary that the government repays the debt out of
a budget surplus during the life span of the generation surviving at the time of
redemption. “This can easily be avoided if maturing bonds are always replaced
by new borrowing.”30

Bowen, Devis and Kopf’s burden argument will hold well only when
taxation is adopted as the measure of redemption. Further, in their analysis
Bowen, Devis and Kopf do not take into account the productive and unproductive
character of the project; if the project financed by borrowing is productive,
even if we accept that G1 has suffered a loss in consumption (as established by
Bowen Davis and Kopf), we may confidently conclude that the output generated
by the project would make good the loss in consumption.

However, S.E. Harris observes, “Once the economist, in a more realistic

mood allowed for unemployment, assumed elasticity in monetary supplies and
agreed that government expenditure could be productive and need not necessarily
be wasteful the case for public borrowing was strengthened.”.31 A.H. Hansen also
declares that, “Public debt is an essential means of increasing employment and
has become an instrument of economic policy today.”32 Harold G. Moulton
maintains that, “Public debt is a national asset rather than liability and it is
essential for the economic prosperity of the country”.33

One man’s asset is another man’s liability and if we take into account
economy as a whole, assets will cancel out the liabilities. Harold M. Groves
further explains that, “…. For every debtor there is also a creditor, it follows that
 31

the existence of an internally held national debt in and of itself will not
impoverish a nation as debtors than it will enrich it as creditors.”34

The advocates of the ‘no-burden’ thesis have innovated one explanation

that internal debt is not a burden if the bonds are held by the taxpayers in the
same proportion as they pay taxes. It creates no economic burden because they
are merely transfers of money from one pocket to another. However, practically it
is difficult to tax only the bond holders and even if it was possible at all, in that
case they would give up the government securities. B. U. Ratchford explains,”
…. The bond holder takes his interest income for granted. He reasons,
quite correctly, that he might have put his funds into other securities and
therefore, he should no be penalized for having bought government bond.
Even though the taxes he pays come back to him in interest he will try just as
hard to escape them, he will regard them with as much distaste, and they will
influence his economic decisions and actions just as much as though they went to
pay interest to someone else”.35

The principal of effective demand occupies a pivotal place in Keynesian

analysis. Total employment depended on it and it in turn depending upon
consumption function and investment function. To maintain adequate effective
demand Keynes advocated that the State Government had to regulate
consumption function on one hand and State investment had to strengthen private
investment on the other hand. The fundamental postulate behind the economic
policy of the “general theory” was contained in the belief that the state must
assume responsibility for stab liability for stabilizing and expending employment
and national income. Keynes states that “I am somewhat skeptical of the success
of a merely monetary policy. I expect to see that State taking an ever greater
responsibility for directly organizing investment. And “that a somewhat
comprehensive socialization of investment will prove the only means of securing
an approximation to full employment. 36 He sought a means of prosperity through
monetary expansion, public investment and other forms of state activity.

Deficit financing, taxation and other fiscal measures which are likely
to impinge upon consumption and/or investment outlays of the private persons
were not to be relied upon so much as deficit spending during unemployment and
32

depression. Redistribution of income could be attained both through public

expenditure as well as progressive taxation. At a time any policy instrument mix
would be decided upon only with references to the most important
socio-economic objectives of the policy fixed by the State government.
Stabilization of process and correction of employment situation could be tackled
by the policy instrument mix which contained effective demand and to check
speculative activity progressive taxation (both direct and indirect) and budgetary
surpluses would be the important policy measures. Keynes used his concepts to
formulate state governments’ policies in economic and social areas. With the help
of consumption function, he showed the necessary of a high rate of consumer
expenditure, which could be obtained by a more equal desirability of steep
progressive taxation and large governmental outlays for social service.
Commonsense meaning of the term investment multiplier is that in time of
depression when private investment lags, government investment in public works
would increase national income not just by the amount of public outlay but by
some multiple of it. In these terms, he makes a plea for public works and
becomes an advocate of public spending: which would provide employment and
add to effective demand. He also stressed marginal efficiency of capital and to
remove the consequences of instability in the marginal efficiency of capital,
he advocated government direction of total investment including public
investment to compensate for the fluctuations in private investment.

Keynesian analysis revolutions practical policies and made State

participation and intervention the fulcrum of economic policy. It was made the
State responsibility to ensure full-employment, regulate economic activity and
promote social justice.

Later economists following Keynes (Keynesians as they are called)

A. H. Hansen, N. Kaldor, R. G. Musgrave, J. K. Galhraith etc. further expanded
and developed Keynes’ ideas. A. H. Hansen in his “Fiscal policy and Business
Cycles” explained with statistical proof the growth of State activity as regards
public works, transport, railways etc., Prof. R. A. Musgrave developed his
“Multiple Theory of Budget Determination” in which he brought out a conceptual
 33

framework through which basis objectives and functions of States were discussed
in the shape of budgetary decisions. He gave the State the following functions.

i) The Service or Want Satisfying Functions

To provide for the satisfaction of those individual wants which the market
mechanism fails to satisfy effectively (e.g. Education) or is incapable of
satisfying (Defense and Justice). To explain the want satisfying function,
Musgrave developed the idea of social wants and merit wants. Basically he
classified human wants into two broad categories, private wants and public
wants. Private wants area felt individually and can be satisfied by a person
through market mechanism by paying for the commodity and getting it. Here the
principle of Exclusion works. Those who do not have the purchasing power to
buy a particular want are left out from its consumption. In relation public wants
are different. They are collectively needed by all, and no one can be excluded
from its consumption of use. Nor as a matter of fact can they be provided for a
got by an individual separately. Wants such as defense and security of the
community, public, health, education, sanitation etc., are not collectively needed
by all nor can anyone be excluding from its consumption. The provision of such
collective wants cannot be done under market mechanism nor is the private sector
willing to invest huge amounts in their development. Hence the role of the State
is to provide for such wants. Public wants of such type were classified by
Musgrave into social wants and Merit wants. Social wants are human wants
collectively felt by all. The society at large feels them and no one can be excluded
from its use. In addition each individual cannot exactly tell how much of the want
he uses or what is the price he is ready to pay for it. Social wants have
indivisibility. The want of social security, defense of the nation, law and order,
police department, education (primary), basic health and sanitation facilities,
goods roads.

While putting the ‘new orthodoxy’ in a nutshell, Prof. Buchanan

concluded that, in this postulate, firstly, the creation of public debt does not
involve any transfer of the primary real burden of future generations; secondly,
the analogy between individual or private debt and public debt is fallacious and
finally there is a sharp and important distinction between internal and external
34

public debt. On the basis of these concluded results Buchanan further established
his own revolt against the ‘no burden hypotheses’.

2.7 DEBT SUSTAINABILITY ANALYSIS

In recent years Underwood (1990)37 in his study, “Sustainability of

international Debt” unpublished study, World Bank, Washington D. C. and
Cohen (1995)38 “Sustainability of African Debt” have undertaken the debt
sustainability analysis. Their analysis regarding debt sustainability mainly studies
whether current debt burden is sustainable and will the country meet its current
and future accumulation of debt servicing liability. They have developed the
concept of “National Solvency” wherein growth of external debt servicing burden
and debt servicing export-import ratios are analyses. For external debt to be
sustainable two conditions are found to be necessary.

a) During the projection period balance of payment equilibrium has

to be achieved without resorting to exceptional financing.

b) The level of indebtedness at the end of the projection period must

be low enough, to make future debt service problem unlikely.
This is evaluated by computing indebtedness indicators, such as,
Debt-GDP Ratio and Debt-Export Ratio. The rule of “Thumb
Warning Sign” is that for external debt to be sustainable the Debt
Service-Export Ratio must be of the order of 200-250 percent.
If the ratio goes beyond this limit, external debt growth should be
considered to be non-sustainable and policy measures have to be
undertaken to reduce this ratio.

In the era of globalization and New Economic Policy, the growth of

external debt and the credit ratings of developing countries made by international
rating agencies are highly correlated. To attract foreign capital inflows, more in
the form of portfolio investment it is necessary that external debt growth is made
sustainable and therefore in fiscal reforms adopted external debt sustainability
assumes importance.
 35

In this context, the balance of payment position of developing countries

becomes very crucial and this depends upon international commodity prices on
which export earnings depends. Here fluctuations in international commodity
prices and the trend of primary commodity prices to remain low always affect the
export earnings of developing countries.

“In case of India, in recent years the market determined exchange rate
regime period, coupled with reforms in external sector and other sectors have
made India’s external sector position a bit comfortable. The Current Account
Deficit-GDP Ratio has remained modest during the 1990s and has averaged
around one percent (in contrast to 2 percent In 1980s), Current Account had a
small surplus in 2001-02 also. Current Account earnings have increased from
8.5 percent of GDP in 1990-91 to about 16.6 percent of GDP in 2001-02.
Indicators of External Sector Sustainability-Debt Service Ratio and External
Debt-GDP Ratio too have declined and Forex reserves today can finance upto a
years of imports. Thus in case of India, in the present situation, external debt
liabilities are sustainable.”39 The paper, ‘Debt Sustainability Issues : New
Challenges for Liberalizing Economics’ is benefited from the discussions of the
‘International Seminar on Issues in Managing External Debt’ and is written by
Raj Kumar. This paper looks at the framework, including the criteria commonly
used for determining debt sustainability. The paper reviews current international
norms that govern the thinking about debt sustainability and considers the
additional key factors that would need to be taken on board in developing a debt
sustainability framework that is more appropriate for countries. The paper is
organized in five sections. Section I considers conceptual issues surrounding debt
sustainability. Section II reviews the commonly used indicators that are relevant
for assessing country’s debt and debt service situation. Section III highlights the
official debt sustainability criteria being implemented internationally. While, the
key vulnerabilities’ shown by East Asian Crisis and their bearing on debt
management are discussed in Section IV. Section V addresses the new factors
that would need to be considered in a debt sustainability framework, including
how debt sustainability should be implemented at the country level. The paper
concludes by reiterating the basic sound debt management principles that
countries must continue to adopt whatever the vulnerabilities they face to
36

optimize the use of borrowed resources to meet their growth and development
objectives.

By 2002-03, the debt of major states stood at 41 percent of their combined

GSDP, higher by 15.7 percentage points than the average for the quinqenium
1992-97. This overall change covers a wide range. Among the major states, the
rise in Bihar was 33 percent, as against a fall in Goa by nearly 1 percent.
Among special category states the disparity was even wider, between Mizoram,
which saw a 39.7 increase in debt ratio, and Arunachal Pradesh and Jammu and
Kashmir, which actually saw a decline, albeit from high initial levels.40

The worrying aspect of the trajectory of debt among the major States is
that the more indebted States prior to 1997 in general saw larger increases in
their debt ratio. Excluding Goa, the rank correlation coefficient between ranking
by levels in 1992-97, and the ranking by change to 2002-03, works out to 0.73,
and is statistically significant.41

The interest rate on state debt crossed over the nominal growth rate of
GSDP during the period 1997-02. The interest rate on debt of major States at 10.4
percent on average in 1997-02 was higher than nominal growth rate on GSDP,
of 9.9 percent. This is in contrast to 1992-97, when the interest rate was at
9.9 percent, as against nominal GSDP growth of 16.1 percent. There was
a similar cross over for special category states, from average interest
of 13.3 percent in 1992-97, to 11.7 and 11.5 percent respectively in 1997-02.
Thus, states will now have to carry overall primary surpluses in order to stabilize
debt as a percent of GSD. Fiscal correction at state level is no longer an option,
but has become an imperative for credibility in financial markets, after
operational sing the analytics of debt sustainability for sub national governments,
states are grouped and ranked by the indicators selected. The selected indicators
are the change in debt/GSDP starting from the average for 1992-97; the sign of
the primary revenue balance in aggregate over 1997-02; own tax buoyancy,
estimated over the period 1990-02; and the annual growth in non-interest revenue
expenditure over 1997-02.41
 37

It can be nobody’s case that states are entirely responsible for the fiscal
situation in which they find themselves. In a fiscal federation, the ultimate
responsibility for macroeconomic control rests with government at the national
level. The provision for this is enshrined under Article 293(3) of the constitution.
Central control of state borrowing upto now has been partial, and has not
extended to borrowing against small savings collections, or direct borrowing
from the public through small schemes floated by the state government. It is only
when the coverage of Article 293(3) comprehensively extends to all avenues of
possible borrowing that enabling conditions for unsustainable debt paths
will have been eliminated. If the TFC recommendation for centrally-set
comprehensive borrowing cap is operationalised, this may now be possible.
However caps set in accordance with the TFC formula may be at odds with the
fiscal deficit correction path set out in FRBMs enacted by states.42

2.8 CRITERION OF DEBT SUSTAINABILITY

In Simple terms, ‘Sustainability’ is defined as the ability to maintain

a constant debt-GDP ratio over a period of time. Sustainability is challenged
when the debt to –GDP ratio reaches an excessive value. 43 Blanchard et al define
sustainable fiscal policy as the one that allows, in the short term, debt-to-GDP
ratio to return to its original level after some excessive variation. Traditionally,
debt sustainability is measured in terms of Domar’s equation,44 which states that
public debt is sustainable as long as the rate of growth of income exceeds the
interest rate or cost of public borrowings. Subject to the condition that the
primary balance is either positive or zero. This condition can be stated as below.

∆d= d (r-g)-z

where, z-primary balance as a share of GDP, D-debt-GDP ratio, g-income growth

rate, r- interest rate

It may be noted that the above equation does not imply that this primary
deficit has to be zero at all times if debt-GDP ratio has to remain constant.
A Stable debt-GDP ratio could be achieved with the primary deficit, provided it
is lower than the spread between growth in GDP and the interest rate.
To understand this point more clearly, the following three terms could be defined:
38

Rate Spread=GDP growth rate-interest rate, Quantum Spread= Debt (1)* rate
spread, Fiscal Imbalance = Quantum Spread + Primary Deficit

It could be derived from Domar’s condition deficit debt sustainability that

if quantum spread together with primary deficit is zero, debt-GDP ratio would
remain constant. Thus, the impact of spread and primary deficit on the debt-GDP
ratio could be determined as shown below.

Impact of Spread and Primary Deficit on Debt-GDP Ratio

Primary deficit (PD) & Fiscal Imbalance

Debt-GDP Ratio
Quantum Spread(QS) (PD+QS)

PD=QS 0 Constant

PD>QS >0 Rising

PD<QS <0 Falling

If the spread between interest and income growth rate narrow down or if
the primary balance becomes negatives, fiscal imbalance (QS+PD) would be
positive and addition to debt would take place at rate faster than the growth rate
of income. This would eventually reflect in rising debt-GDP ratio and debt would
become unsustainable.

The essential condition, which emerges from above, is that fiscal

imbalance must either be zero, or less, if the debt-GDP ratio has to stabilize or
start falling.

2.9 BURDEN OF PUBLIC DEBT

The Concept of debt burden has been an area of intense controversy in

public finance by drawing an analogy between private and public debt the
classical economists considered all the public debt as a burden. They postulated
that taxes reduced mainly consumption while internal borrowing led to
a reduction in private capital formation. To quote Pigou, finance by loans does hit
capital and through this, the economic fortunes of future generations somewhat
more hardly than finance by taxes.45
 39

As David M. C. Wright observes, The financial burden of the national

debt is to be measured by the effects of the interest charges and the taxes for
interest bear to the national money income is the question of primary importance.

Sometimes the concept of burden is explained in terms of the nation of

abstinence or pain-cost doctrine and opportunity cost, when a loan is obtained by
the government, resources are transferred from private hands government and
those who contribute to government loan abstain from consumption current
income and undergo the pain of abstinence which may be called a burden caused
by the incurring of public debt. However, the concept of burden based on the
notion of abstinent and opportunity cost is not quite acceptable if people
contribute to public loans voluntarily.46 When the people voluntarily lend to the
government it means by investing in government securities, they are moving to
a preferred position on the utility surface.

2.10 CLASSICAL VIEW ON THE BURDEN OF PUBLIC DEBT

Adam Smith observes that public borrowings does not create new capital
thus new capital , however which they in this manner either bought or borrowed
of other people must have been employed as all capital are engaged in
maintaining productive labour but the views of Adam Smith are more liberal.
He does not hold the view that the utilization of capital by government does
necessarily destroy the actual existing capital.47 Ricardo too holds the views that
public borrowing is withdrawn from the productive capital of the nation. To him,
this distress of industry generally was due to want of the capital absorbed by the
debt.48

J. B. Say, in his opinion, there is a remarkable distinction between an

individual borrowing and a borrowing government the former borrows capital for
the purpose of beneficial employment the latter for the purpose of the barren
consumption and expenditure. Say vehemently reject the argument that as a debt
it imposes no burden on the economy by arguing that government bond is simply
a parchment and not properly and as such holding of debt bond is not like holding
of real wealth.49
40

J. S. Mill goes a bit off the classical path and regards public debt a burden
not in all circumstances and sets the rate of interest as a test of it. To him rise in
the rate of interest is a positive proof that the state government is a competitor for
capital with the ordinary channels of productive investment and is carrying off
not merely funds which would not, but funds which have founds productive
employment within the country. A borrowing capital causing rise in interest rate
is a positive burden. Being a supporter of the wage funds theory, he observes that
public borrowing is acceptable only when it is provided out of additional savings
because, if it is not met out of the additional saving it will be withdrawn from the
wage fund and thus it will affect adversely the living condition and the efficiency
of the workers.50

T. R. Malthus is an outstanding dissenter it remained for Malthus along

among the prominent classists to give a decidedly modern tone to the case for
public debt. To him public borrowing not only augments production in the
economy but also avoids glut in the market.

The Classical theory is criticized mainly on two grounds. Firstly, every

government expenditure is not always unproductive; hence public borrowing may
not be always a burden upon the economy. Secondly, the traditional view
regarding the shifting of the debt is not correct. The real burden must be borne in
the period in which public expenditure has been incurred through government
borrowing programmer because resources are withdrawn from private use and
put into public projects only in this period.

Public borrowing programmer generates some problems to be faced by

future generations in the form of adverse effect upon the economy. But there is
no shifting of the basic burden to the future generation. Future generation not
only inherits liabilities of the payment of interest and principal from the present
generation but also inherits assets in the form of the form of the right of receiving
the interest and principal. Thus, the interest and principles on the payment side
interest and principal on the receipt side belong to the same generation; there is
no inter-generation transfer but a transfer within the same generation.51
 41

2.11 MODERN VIEWS ON THE BURDEN OF PUBLIC DEBT

The great depression of 1930; and the Keynesian revolution paved the
way for the development of the modern view of public debt.

Those who follow Keynes take into account the income generating aspect
of the public debt and reject any possibility of internal debt being burden upon
the community. Economists like Lerner share the opinion that, “internal debt
inflicts no burden simply because it is a transfer of fund from one pocket into the
other from the left hand to the right hand.” He further maintains,
“An interpersonal or international loan yields the borrower a real benefit.
It enables him to consume or invest more than he is earning or producing.
And when he pays interest or repays the loan he must tighten his belt, reducing
his consumption or his investment. In the case of national debt we have neither
the benefit nor the burden. The belt cannot be let out when borrowing and need
not be tightened when repaying.”52 Their argument is purely macro and based on
the ‘one big family’ analogy. Since for every debtor there is also a creditor,
it follows that the existence of an internally held national debt in and of itself will
not impoverish a nation as debtors than it will enrich it as creditor.

The point which we have to consider here is whether the loan is internal
or external. The magnitude of burden depends upon this factor to a great extent.
It would be desirable, if these two aspects of public debt are examined
separately.53

2.12 MODIGLIANI’S BURDEN THESIS

Prof. Modigliani’s analysis of the burden of public debt is different from

that of his predecessors. He is of the opinion that public debt is a burden on the
future generation because of the loss of partial capital formation and the
consequent reduction of potential future income what the government borrows
funds are transferred from private hands to the government causing a fall in
private capital formation. He argues that society bear no burden in the current
period when public expenditure are financial out of private saving because people
invest only to consume in latter periods. Suppose government borrow Rs. 100,
the reduction in private sector’s capital formation by that amount. If the effective
rate of return on private investment is equal, to 5 percent potential future income
42

is reduced by Rs. 5 for every Rs. 100 borrowed by the government and this asset
holdings of people in the form of governments bonds will certainly affect their
willingness to save and there will be a fall in the rate of saving in the economy.

Even in depression conditions people accept the government securities as

real wealth and gradually reduce their rate of saving over time.

He summaries his burden thesis as follows

1. These conclusions hold in reverse in the case a reduction in the

real national debt. That is, such a decline is burdensome to those
present at the time of the reduction and tends to generate a gross
gain for those living beyond.

2. If the rate of interest which the government borrows can be taken

as a good approximation to the marginal productivity of private
capital, then the gross burden to future generations referred to
under & can be measured by the interest changes on the national
debt.

3. The gross burden may be offset in part or into or may be even

more than offset, in so far as the increase in the debt is
accompanied by government expenditure which contributes to the
real income of future generation’s e.g. through productive public
capital formation.

The community income need not fall simply because of the fall in the
private capital formation. If government’s capital formation increases by
adopting borrowing methods and borrowed funds are utilized productively the
income of the nation is bound to rise. So the important problem is that whether
the borrowed funds employed productively and contribute to economic
development.

Prof. Modigliani himself accepts that through productive capital

formation, the burden that falls on the future generations might be offset full or in
part.54
 43

2.13 MUSGRAVE ANALYSIS ON THE BURDEN OF PUBLIC DEBT

Prof. Musgrave explains that the burden of debt financed expenditure

shifts via reduction in private investment. He proves this by an example of
municipal finance in which the burden is shifted to future generations reducing its
consumption and investment without any reduction in investment in the initial
period. In this case, Prof. Musgrave states, the use of pay-as-you-use finance for
durable public facilities yielding services over a period of time. This pay-as-you-
use doctrine of Musgrave declares that public debt issued for such purposes
should be repaid as the benefits from the initial expenditures are being exhausted

Prof. Musgrave considers a public project yielding services over three

periods and assumes that loans advanced by any one generation must be repaid
within its life span.55

2.14 CONCLUSIONS REGARDING BURDEN OF PUBLIC DEBT

External public debt is more burdensome than the internal public debt.
In the case of external debt, the gross national product is reduced, due to the
payment of interest and the principal. “Internal debt causes no direct money
burden. It is a debt owned by the people to themselves”(Dalton). But there is
economic burden of internal debt; it depends upon the tax pattern and the pattern
of debt ownership. Even if the holders of government securities are the same
people as the tax payers, there is a burden on them; then the tax payer’s desire to
work, save and invest may fall.

If taxes are more progressive than the ownership of the public debt,
the redistribution of income is in the direction of equality. But if taxes are less
progressive than the pattern of debt ownership of income is in favor of higher
income groups and this increases inequality. This is undesirable.

Thus, progressive taxation accompanied by a less progressive pattern of

debt ownership (i.e. smaller households holding the public debt) imposes
a smaller net burden. Public debt incurring to bring about the improvement of
consumption increase in employment, creation of capital assets etc, imposes
a smaller net burden.
44

2.15 CONCLUSIONS

Looking to the facts in India, a major part of public debt is held by banks,
rich traders, individual entrepreneurs and private corporations. Thus, the pattern
of public debt ownership is very progressive. Most of the public debt is held by
the rich, on the other hand, indirect taxes from 80 percent of the total tax
proceeds, which means there is a greater burden on the poor as these taxes are
regressive in effect. Thus, in India, the pattern of debt ownership is very much
progressive and the pattern of taxation is highly regressive, India’s internal debt
is highly burdensome from the individual’s point of view.

Today, incurring of public debt, though burdensome from the equity point
of view is nevertheless inevitable. If the levels of income and employment are
rising more proportionately along with the public debt, then the burden of such
debt is bearable and should cause no concern.

The magnitude of interest debt is not a correct measure of debt burden.

The principal determinants of debt burden are:

1. The magnitude of annual transfers for debt service.

2. The pattern of ownership of public debt within the economy

3. The type of tax system

4. The level of national level.

 45

2.16 REFERENCES

1. Khuperker. S. A. (2003). “The Trends in India’s Foreign Debt in the

Context of New Economic Policy : 1980 to 2000” (unpublished M. Phil
Dissertation)

2. Adam Smith (1954). “An Enquiry into the Nature, Causes of the Wealth
of Nation”, Everyman’s library edition (J. M. Dent & Sons), London,
Book-IV, Chapter-IX (quoted in A. A. Dange, unpublished Ph. D. Thesis)

3. Adam Simth, “Wealth and Nations ,Book-V, Chapter-I, Part-III(quoted in

A. A. Dange, unpublished Ph. D. Thesis)

4. Ibid; Part-II

5. Say J. B., “Course Complete D‘ Economic Politique Pratique 3rd edition,

Part-7, Chapter-XIV

6. Say J. B., “A Treatise on Political Economy (Translated by C. E.

Princsep), p. 442

7. Quarterly Journal of Economics(May, 1954). cited in Readings in Fiscal

Policy, pp. 6,7

8. Richardo D., “Principles of Political Economy and Taxation ‘works and

correspondence of D. Richarda, Vol. 1, pp. 243-49

9. Ibid; pp. 250-51

10. Ibid; pp. 252-53

11. Mill J. S. (1929), “Principles of Political Economy; Ashley ed.

Longman’s Green and Co., London, Book-V Chapter-1, p. 8

12. Ibid; Book-V, Chapter-II, p.7

13. Mill J. S. “Principles of Political Economy”, p. 800

14. William Petly, “A Treatise of Taxes and Contributions , Chapter-I, Last

Paragraph, (Quoted by J. R. Macculloch: The literature of political
economy, p. 318)
 46

nd
15. Malthus T. R. (1886) “Principles of Political Economy”, (II ed)
London, William Pickering, P-209 quoted by J. Burkheadin Balanced
Budgets, A. P. Leaner, Economics of Employment (1955), p. 274

16. Malthus T. R. (1886). 12 Notes on Malthus, ‘Political Economy: Works

and Correspondence of D. Ricardo; Vol. II pp. 411-412

17. Pigon A. C., “Economic of Welfare,” E, L, B, S Macmillan edition 4th, p.9

18. Khuperker. S. A. (2003). “The Trends in India’s Foreign Debt in the

Context of New Economic Policy: 1980 to 2000” (unpublished M. Phil
Thesis)

19. Lerner A. P. (1955). “Functional Finance and the federal debt social
research”(Feb. 1943), reprinted in readings in fiscal policy (George
Allen and Unwin, London) p. 475

20. Buchanan M. (1958). “Public Principles of Public Debt: A Defense &

Restatement “Richard. D., Irwin, Illinois, p. 1

21. Franco Modigliani (1964). “Long run implication & Alternative fiscal
policies And the burden of nation debt”, Economic Journal, LXXL, Dec-
1961, P-730, Reprinted in J. M. Ferguson (Ed) Public Debt and Future
Generations the University of North Carolina Press, p. 187

22. Buchana. M. “Principles of Public Debt, Preface –VIII

23. Ibid; pp. 33-34

24. Ibid; p. 40

25. Chapel-Hill, Public Debts, Cost Theory and the Fiscal Illusion (1964),
Public Debt and Future Generations (Ed.) J. M. Ferguson.

26. Boven, Davis, Kopf, The Public Debt, A Burden on Future Generati
American Economics Review (September, 1960)

27. Ibid. p. 86.

28. Ibid; p. 88
 47

29. The otherwise recognized fact that even if loan finance fails to dampen
private investment the present generation can still shift at least a part of
the burden of government spending to future generation’ – B.D.K.

30. ‘G makes good this impairment right away by restricting its own
consumption’- Carl S. Shoup, Debt Financing and Future Generation,
Economic Journal Vol. LXXII, (Dec., 1962).

31. Harris S. E., op. cit, p. 45

32. Hansen, H. A. (1941). “Fiscal Policy and Business Cycle”, p-152-161, 33

Harold G. Moulton, (1943); The New Philosophy of Public Debt, p. 45

33. Harold M. Groves, Financing Government (1958). p. 580

34. The Burden of a Domestic Debt, American Economics Review (Sept-

1992) citied in readings in fiscal policy: op. cit 456

35. Dange A. A. (1991). “Role of Public Debt in Economic Development with

Special Reference to Maharashtra” 1961-90(unpublished PhD thesis)

36. Underwood, Sustainability of International Debt (1990)

37. Cohen, Sustainability of African Debt (1995).

38. Pattnaik R. K., M. Kapur, S. C. Dhal, Exchange Rate Policy and

Management, Economic and Political Weekly, Vol. XXXVIII No. 22,
(May-June, 2003) pp. 2139-53.

39. Rajarama Indira, (2005).“A Study of Debt Sustainability at State

Level in India”, National Institute of Public Finance and Policy, New
Delhi, Reserve Bank of India of Bulletin, Oct 2005, pp. 865-866

40. Dr. Rao S. R. K., Bank Economists’ Meet, 1986 Punjab National Bank,
New Delhi.

41. Ibid; p. 40

42. Mohan R. (2000). Fiscal Corrections for Economic Growth: Data

Analysis And Suggestion; EPW, June-10-16, Vol. 35, No-24, pp-2027-36

43. Ibid; pp. 2036-37

 48

44. Pigou A. C. (1929). “A Study in Public Finance “ 2nd edition, Macmillan,

London

45. “The Economic Limit and Economic Burden of an Internal-held National

Debt; Quarterly Journal of Economics IV, Nov-1940, p. 119

46. Adam Smith, ‘An Enquiry into the Nature, Cause of the Wealth of
Nature”, p. 410

47. Ricardo. D. “Principles of Political Economy (ed) ECK Govern, p. 228

48. Says J. B “A Treatise on Political Economy Translated by (C. R. Prinsep)

p. 442

49. Mill J. S. “Principles of Political Economy, Vol. II, p. 480

50. Ibid; Vol. I, P-III

51. Groves, Harold, (1958). “Financing Government, p. 580

52. Musgrave (1959). The Theory of Public Finance, New York, p-118

53. Ibid; p. 119

54. Ibid; p. 119

55. Dange A. A. (1991). Role of Public Debt in Economic Development With

Special Reference to Maharashtra: 1961-1990 ; (Unpublished Ph. D,
Thesis)