Introduction
The Public debt corresponds to all financial commitments made in the form of loans by the State, public authorities and organizations that depend directly on them.
The public deficit, on the other hand, is the state’s budget balance over a year. In other words, the deficit is a flow, while the debt is a stock.
To what extent is the State able to finance its budget deficit through recourse to debt?
I- Definition and operation of public debt
Generally, the public debt evolves constantly in line with loan repayments made by the State and public administrations and new loans they take out to finance their deficits, thus impacting the budget balance.
1- State budget
It should be noted that the state budget corresponds to all of its resources on the one hand, and its expenditures on the other :
- Resources : primarily come from taxes and duties paid by citizens and businesses ;
- Expenses : correspond to the money used to finance public action: education, justice, police, transport, etc.
Thus, the deficit appeared when expenses exceeded revenues, for two reasons :
Part of the public deficit stems from the imbalance between government spending and tax revenue. When public finances are in deficit, this increases the debt.
- Part of the public deficit stems from the imbalance between government spending and tax revenue. When public finances are in deficit, this increases the debt.
- The other part comes from the financial burden associated with paying interest on the debt.
To finance this difference and allow for the continued funding of public services, the State takes out loans. All of these loans together constitute the public debt.
Thus, borrowing is used to finance investments or meet cash flow needs :
The State issues debt securities (bonds, Treasury bills) on the financial markets to cover its budget deficits and repay its maturing debts.
The state therefore borrows money on the financial markets for two reasons :
- To finance its budget deficit ;
- Repay the portion of one’s debt that is due.
2- State lenders
The state is not an ordinary debtor, its solvency does not follow market laws. It is solvent because it is strong enough to make its debt solvent.
The state is not solvent because it manages public funds well, but because it can strengthen its fiscal, regulatory and monetary powers at any time if necessary.
Moreover, and to unlike businesses or households, the state does not primarily finance its debt through bank loans but by issuing financial securities, especially bonds, on the financial markets.
Thus, the main lenders to the State are :
A- Institutional investors
Banks, insurance companies and pension funds buy the majority of the securities;
B- Foreign actors
Investors and institutions from other countries hold a large share of the national debt;
C- Central banks
The central bank can hold a portion of the debt through asset purchase programs;
D- Savers and residents
Households lend indirectly through their savings held in banks or funds.
3- How does loan repayment work?
For loan repayment, the government pays interest to the bondholder once a year in the form of coupons. The initial principal is repaid in full at the bond’s maturity.
In practice, the state will never actually repay the debt. It will borrow again to repay the old debt, and will thus always maintain a significant debt burden.
However, in order for creditors to agree to lend at low cost, the state must demonstrate that it could repay its debt if it so desired.
The state is not a household, nor a business, therefore, what may seem like common sense in matters of family management does not apply to public authorities, for at least two reasons :
- The first is that we can consider that the State is eternal, so that it is not required to repay its debt and balance its budget over a life cycle.
This means that the budgetary constraint of sustainability, which requires that the present value of its future revenue and expenditure flows be positive or zero, is no longer imposed;
- The second is that, unlike private agents, the decisions it makes, particularly regarding budgetary policy, influence economic activity on a large scale.
II- How does the State finance its deficit?
The public deficit corresponds to a negative annual balance in the state budget between revenues and expenditures, where expenditures exceed revenues.
1- Public revenues
Generally, public revenue comes from two sources :
A- Tax revenues
Indeed, tax revenues, largely composed of taxes which make up more than 95% of total revenues, can be divided into three categories :
- Consumption taxes
Consisting largely of consumption taxes, mainly Value Added Tax (VAT) and Domestic Consumption Tax on Energy Products (TICPE).
- Income taxes
The levies on income are income tax (IR), corporation tax (IS) and income of persons who carry out a commercial, industrial or craft profession on their own account, in addition to the tax on industrial and commercial profits.
- Property and capital taxes
Property and capital taxes consist of land tax, capital gains taxes (on real estate and securities), real estate wealth tax, and registration, gift, and inheritance taxes.
B- Non-tax revenue
Non-tax revenues are mainly income from state assets, income from state industrial and commercial activity, remuneration for services rendered such as audiovisual fees and loans contracted by the state.
2- Borrowing on the financial markets
Generally speaking, when there is a budget deficit for a given year, it means that throughout that year, the State will have to borrow to fill the gap between its revenues and its expenditures, in other words to meet its financing needs.
The government borrows money by selling short, medium, and long-term bonds on the financial markets. Businesses and households, as well as foreign investors, buy these bonds due to the globalization of financial markets.
Government bonds are attractive to investors because the government pays a fixed interest rate and they are generally considered a safe investment : the risk of government default is, in fact, generally low.
3- Issuance of government bonds
A bond is a sovereign debt security, issued by a national government to raise funds to finance its public spending.
Overall, the issuance of government bonds is a financial operation by which a state borrows money from investors in the bond market to finance its financing needs, projects or infrastructure.
By purchasing a bond, the holder lends money to the issuer in exchange for regular interest payments called coupons.
Generally, the lender recovers their capital when the bond reaches maturity or even before through its sale, insofar as it is a security traded on the stock exchange.
It should be noted that bonds can have a fixed rate, offering constant interest, or a variable rate, adjusted periodically according to a benchmark index such as market interest rates.
These financial instruments can be essential for investors seeking a regular income while diversifying their portfolio.
Conclusion
The public deficit is the state’s budget balance over a year and the succession of deficits encourages the emergence of new deficits. Whereas the public debt is nothing more than the sum of past deficits.
Unlike households and businesses, the State has the particularity of continually borrowing to repay its debts: it is said to “roll over the debt”.