How do budget deficits influence future tax rates and public services over time? Why do persistent budget deficits increase pressure on governments to raise taxes or cut spending? What risks do budget deficits pose to economic stability, living standards, and intergenerational equity?
This blog examines how budget deficits and national debt shape long-term fiscal outcomes, particularly their impact on future tax rates and the quality of public services. It explains the difference between annual budget deficits and accumulated national debt, why governments borrow, and how interest costs eventually place growing pressure on public finances. By exploring when borrowing can support long-term economic growth versus when budget deficits become structural, the article highlights how fiscal choices today constrain or expand future policy options.
The post also analyzes how sustained budget deficits affect employment, living standards, and a government’s ability to respond to future crises. It outlines the trade-offs governments face between higher taxes, reduced public services, and continued borrowing, while examining the broader systemic risks for large, globally integrated economies. Ultimately, the blog argues that the consequences of budget deficits are not inevitable, but depend on whether fiscal policy is guided by long-term investment, economic literacy, and intergenerational responsibility rather than short-term political pressure.
National debt. Deficits. Rising interest burdens. None of these topics fires the popular imagination. Debates about them do not make the front page news. But tax increases, reduced public services, and cuts to welfare programs do. In an era shaped by globalization, these outcomes are increasingly linked to forces beyond national borders.
It’s incumbent upon us to understand the relationship between the two, so that when we vote and voice our opinions, we do so from an informed position. That is the focus of this piece.
Understanding Budget Deficits and National Debt
Understanding the public finances of a nation-state requires understanding two foundational concepts: the distinction between annual budget deficits and the accumulated stock of national debt.
A budget deficit occurs when a government’s expenditures exceed its revenues within a given fiscal year, requiring it to borrow to bridge the gap.
National debt, by contrast, represents the tallied sum result of all past budget deficits. Deficits can be reduced by budget surpluses (if they occur).
While the two concepts are often conflated in public debate, understanding their relationship is essential to evaluating the long-term consequences of taxation and public services.
Governments incur budget deficits for a variety of reasons. Borrowing allows states to smooth economic cycles, supporting demand during recessions when private spending contracts. It also enables governments to fund infrastructure, education systems, or national security capabilities. Investments such as this accrue benefits over decades rather than within a single budget year. And in times of crisis (financial, geopolitical, or public health), budget deficits often expand sharply as governments focus on more pressing priorities than balancing the books.
However, as a government borrows more, and the national debt grows, so too does the share of government revenue devoted to servicing that debt. And “government revenue” comes from one source: taxation. Therefore, as interest costs rise over time, they crowd out other priorities and limit future policy options, while also increasing the likelihood of future tax increases.
When Government Borrowing Supports Long-Term Growth
Not all budget deficits carry the same economic implications. The critical distinction lies in how borrowed funds are used and whether they contribute to future productive capacity. When governments borrow to finance investments that raise long-term economic growth, the resulting expansion of the tax base can help offset the fiscal burden of debt.
Economic history offers numerous examples of borrowing that ultimately strengthened public finances rather than weakened them. Well-designed infrastructure can increase productivity across entire economies. Investment in education and skills enhances workforce participation and earnings potential, translating into higher future tax revenues.
The sustainability of budget deficits, therefore, depends heavily on the relationship between economic growth and interest rates. If an economy grows faster than the interest rate on government debt, the relative burden of that debt can stabilize or even decline over time, even in the presence of moderate deficits. It’s not dissimilar to a manufacturing business deciding to borrow money in order to finance a capacity expansion at its factories. The bet made is that revenues and positive cash flows will offset the principal and interest repayments on the debt.
The Fiscal Trade-Offs of Persistent Deficits
It is well documented that challenges arise when budget deficits persist beyond periods of economic weakness and become a structural feature of government finance. A turn of phrase that I’ve always found useful for distilling this down is that governments are putting more and more on the “national credit card.” Chronic deficits that accrue in this way gradually narrow the range of policy options available to future governments.
One of the most visible consequences of persistent budget deficits is the growing share of public expenditure devoted to debt servicing. As interest payments consume a larger portion of the budget, fewer resources are available for discretionary spending on public services, such as healthcare, education, and infrastructure maintenance. This state of affairs can force governments into difficult trade-offs: either raise taxes, reduce services, or borrow even more to maintain existing commitments.
Perhaps most critically, sustained budget deficits reduce a government’s ability to respond effectively to future shocks. The capacity to borrow during emergencies is weakened when the national credit card is already close to being fully “maxed out.”
Implications for Future Tax Rates
As national debt accumulates, the question of how it will ultimately be financed becomes unavoidable. While governments can roll over debt for extended periods, persistent budget deficits tend to exert upward pressure on future tax rates, particularly once interest payments begin to absorb a growing share of public revenue and lenders start to worry about credit risk.
Under sustained fiscal pressure, governments typically consider a familiar set of tax adjustments. These may include increases in broad-based consumption taxes, higher personal income tax rates, reduced thresholds for top marginal brackets, or changes to corporate taxation and capital gains regimes.
The distributional effects of such tax changes are rarely neutral. Consumption taxes tend to fall more heavily on lower- and middle-income households, while income and capital taxes disproportionately affect higher earners and investors.
There is also a broader economic risk associated with higher taxation under fiscal stress. If tax increases are poorly timed or excessively front-loaded, they can dampen consumer spending, reduce business investment, and slow economic growth.
Consequences for Public Services
When budget deficits persist and political resistance limits tax increases, pressure inevitably shifts toward public spending. Discretionary expenditures are often the first to come under scrutiny. Infrastructure maintenance and preventative health programs are particularly vulnerable, as their benefits are realized over extended horizons.
This distinction between gradual erosion and abrupt cuts is critical. Sudden austerity measures tend to attract public attention and political backlash, whereas slow degradation often proceeds with limited scrutiny until service failures become acute. Persistent budget deficits increase the likelihood of the latter, thereby embedding fiscal stress into the everyday functioning of public institutions.
The long-term implications extend beyond immediate service delivery. When public services deteriorate, households are often forced to compensate by incurring higher out-of-pocket healthcare costs and private education expenses. This shifts financial risk from the state to individuals and can widen inequality, particularly for those with limited capacity to absorb additional costs.
Debt, Employment, and Living Standards
The interaction between public debt, employment, and living standards is complex, but the direction of influence is clear when fiscal adjustment becomes unavoidable. Public sector hiring freezes, reduced capital projects, and cuts to support programs can directly weaken employment growth, while higher taxes may indirectly suppress private sector demand.
In economies where government spending plays a significant role in supporting employment, fiscal tightening can contribute to higher unemployment or underemployment. These effects are particularly pronounced during periods of weak private sector growth, when public spending acts as a stabilizing force.
The consequences for living standards extend beyond employment figures. Reduced public spending can lower household income through diminished transfers, higher user fees, or reduced service quality, while tax increases reduce disposable income directly. At the same time, households may face higher costs of living as public services retreat and private alternatives become necessary. The cumulative effect is often a sense of economic squeeze, where wages stagnate while essential expenses continue to rise.
Systemic Risks for Large Economies
The question that often arises when I discuss this topic is, “Don’t large economies have the ability to ride out tougher periods and deficits?” For example, in the case of the US, shouldn’t it be the case that its deep capital markets, reserve currency, and institutional credibility could allow it to sustain budget deficits for longer periods and at lower borrowing costs than smaller or less stable states?
There is merit to that argument. But size and global integration merely delay the manifestation of risk and alter its transmission channels.
As budget deficits persist, even large economies become increasingly dependent on sustained investor confidence. Government bonds are priced not only on current fiscal conditions but on expectations about long-term debt trajectories, political stability, and policy coherence. When doubts emerge, borrowing costs can adjust rapidly. The short-lived UK government of Liz Truss learned this in spectacular fashion, with borrowers exerting their influence to raise interest rates demanded on UK public debt as the perception that the UK government was a less reliable borrower took hold in the market.
A relatively small increase in yields, when applied to a vast stock of outstanding debt, can materially worsen fiscal balances, creating a self-reinforcing cycle of higher interest payments and larger deficits.
Because large economies are deeply embedded in global financial systems, fiscal stress does not remain contained within national borders. Government bonds often serve as benchmark “risk-free” assets, collateral in financial markets, and anchors for global capital allocation. A reassessment of their risk profile can ripple outward, affecting exchange rates, equity valuations, and credit conditions across multiple countries. In this way, persistent budget deficits in major economies carry the potential for spillover effects that threaten broader financial stability, particularly during periods of already heightened global uncertainty.
The Long-Term Policy Dilemma
At the heart of sustained budget deficits lies a structural policy dilemma that is as much political as it is economic.
The intergenerational consequences of this dilemma are significant. Persistent deficit spending effectively shifts the burden of today’s consumption and policy choices onto future taxpayers, who inherit higher debt levels and reduced fiscal flexibility. While borrowing can be justified when it finances investments that raise long-term productivity or resilience, deficits driven primarily by recurrent spending create obligations without corresponding assets.
Aligning political incentives with fiscal responsibility remains one of the most difficult challenges in public finance. Fiscal rules, independent budget offices, and long-term projections are designed to impose discipline. Still, they often struggle to compete with electoral pressures and crisis-driven policymaking and are quickly discarded or amended (especially in election years!). The result is a pattern in which budget deficits are tolerated during downturns, accommodated during expansions, and only addressed when constraints become binding.
Ultimately, the dilemma is not whether governments should ever run deficits, but whether they can distinguish between borrowing that strengthens future economic capacity and borrowing that merely postpones difficult decisions. Without that distinction, fiscal policy risks becoming reactive and short-term rather than strategic and long-term as it should be.
Key Takeaways
Budget deficits are neither inherently reckless nor inherently virtuous. They are simply tools that can either expand a nation’s future economic capacity or quietly erode it, depending on how they are used and how long they persist.
History offers ample evidence that governments can course-correct when fiscal choices are guided by long-term thinking rather than short-term expedience. Budget deficits that finance productive investments in the people of a nation, via improvements to education, infrastructure, and innovation, can strengthen growth in ways that make future obligations easier to manage rather than harder to bear.
Future fiscal debates will need to move beyond the binary framing of “more spending” or “higher taxes” and toward a clearer assessment of value, durability, and intergenerational fairness. A highly economically literate generation that is moving through our universities understands this challenge implicitly.
The long-run consequences of budget deficits are not preordained. With thoughtful policy design and a willingness to prioritize sustainable growth over political convenience, fiscal policy can reassert its role as a stabilizing force that supports prosperity today without compromising the public services, economic flexibility, and social trust that future generations will depend upon.
