3 - Financing Government

Summary

Government expenditure needs to be financed. The two ways to do so are via taxes or via deficits and debt. For the first 90 of the past 150 years, public expenditure broadly grew in line with revenue, except during wars and times of crises. This changed fundamentally in the 1960s and early 1970s as the ‘Keynesian revolution’ took hold.Over the past fifty years, revenue rose strongly, but public spending often increased even faster. Chronic deficits stoked a high and growing stock of public debt in much of the advanced world. Public debt in the largest countries is now similar to the level prevailing at the end of the Second World War. Future governments will also face significant liabilities from increasing public expenditure related to population ageing, as well as fiscal risks from the financial sector. These liabilities and risks imply higher expenditure which will need to be financed. At the same time, there are political and economic limits to both taxation and indebtedness.