By: Thorsten_Polleit

I. The Incentives for Holding and Issuing Government Debt

Many people invest their savings in government bonds. They are obviously of the opinion that government bonds offer an attractive yield and represent fairly little risk.



But wait a moment. What do government bonds actually stand for? Who pays the interest on these bonds? And who repays them?

A government bond represents a loan to the public sector, and the government uses the funds to finance its outlays: it pays politicians, bureaucrats, favored groups, social security, military spending, infrastructure, etc.

The government takes recourse to debt financing because tax revenues typically don't cover its outlays. But why doesn't the government raise taxes, or reign in spending, to fill the financing gap?

People don't like to pay taxes. At the same time, they do like to receive financial benefits from the government. Those in government, in turn, love to make people happy by giving them money — as this is the best way to secure reelection.

Of all the financing instruments available, debt financing is, economically speaking, the most attractive from the viewpoint of the government and the electorate.

First, via debt financing the government can finance its hand-outs without burdening the taxpayer. The electorate can enjoy financial benefits for which it doesn't have to pay.

Taxpayers just have to shoulder the interest-rate costs on government debt, whereas the repayment of the debt is transferred onto future generations of taxpayers.



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