Facing Constraints: Risks of Rising Debt Levels
- The Wilberforce Society Cambridge
- 5 hours ago
- 5 min read
Written by Max Bardong
Edited by Bhing Turongpun
Government debt can be something extremely useful. Most notably, debt helps finance government spending that goes beyond tax revenues, i.e., spending that would otherwise require higher taxes. The most well-known application of this goes back to John Maynard Keynes: in economic crises with high unemployment, Keynes advocated for increased government spending to make up for low aggregate demand and stimulate private consumption and investment via “multiplier” and “accelerator” effects (1).
Funding those stimulus programmes can be done by a) increasing taxes, and b) taking on more debt. Option a) is undesirable: Increasing taxes to finance higher spending counteracts expansionary effects and undermines the very objective of reviving the economy (2). For this reason, option b), temporarily taking on more debt instead (“deficit spending”), can be a more effective strategy to fight unemployment and lift economies out of recessions.
Of course, there is also a downside to public borrowing. For instance, the United Kingdom (UK) demonstrates how increasingly taking on government debt can become a burden for policymaking over time.
The UK public debt (as a percentage of GDP) has risen substantially in the last 25 years from less than 40% in 2000 to more than 100% in 2025 (3). Most notable have been the financial crisis in 2008 and the pandemic and energy price shocks in 2020 and 2022 as drivers of public borrowing. Debt servicing costs have accordingly risen, particularly since the Bank of England increased interest rates in 2022 and since Liz Truss’s “mini-budget”, which eroded trust in the UK as a debtor and sent government bond yields spiralling in September 2022 (4). Yields of 10-year UK government bonds have stayed elevated since (4).
To avoid a further rise in borrowing costs, Chancellor Rachel Reeves announced a higher tax burden in her 2024 and 2025 budgets. Taking this decision in a time of high uncertainty and rather low growth (5)(6) demonstrated the dilemma the UK is currently in. Failing to raise taxes would increase risk premia and debt servicing costs, which would worsen the UK’s fiscal position even more. On the other hand, higher taxes create further drag on the UK economy, which will potentially decrease tax revenues and worsen the UK’s fiscal position in the long run, too. Both choices – raising or not raising taxes – therefore come with adverse effects for the UK economy, because of the already high public debt level.
The situation of other European economies is similar. The most obvious example is France, whose 10-year government bond yields have recently surpassed Italy’s after the French parliament had not been able to bring the annual deficit, currently at 5.8% of GDP, down (7). French public debt currently stands at 116% of GDP (8). Even German government bond yields rose after debt-financed infrastructure and defence investments of more than €500bn had been announced in March 2025. Debt-servicing costs can only be expected to grow as deficits go up. Public debt levels in France and Germany therefore continue to rise in the foreseeable future, too.
The central risk of high levels of public debt is the increasing burden of interest payments on government revenue. These payments, taking up more and more of the government budget, leave less for spending on consumption and investment – key drivers of short- and long-term economic growth. The need to carefully weigh whether the return of debt-financed spending is greater than the (interest) costs that go along with it is thus indispensable.
Let me be clear: I am not arguing for blindly cutting spending to get back to a surplus in Europe at all costs. The current US administration (“Trump II”) and the new US Security Strategy, in particular, have shown that Europe needs to improve its military capabilities quickly to get more independent in defending itself. Over the short term, there is simply no alternative but to finance this by taking on more debt.
Rather, I am calling on European governments not to take on additional debt unless it is expected to deliver a return at least as high as the interest costs. This way, debt pays for itself by generating returns that cover its interest costs. For example, expenditure on sustainable infrastructure or education is expected to benefit the future economy by increasing the physical and human capital stock. This will lead to future economic growth and higher tax revenues, which can be used to repay the debt. In contrast, higher pension spending is not expected to generate comparable economic returns. While socially important, such spending should not be financed at the cost of higher public borrowing. Adhering to this returns-based approach of public borrowing is an important step to ensure public finances are on a sustainable path.
Ironically, Germany, despite its reputation for fiscal discipline, has not been setting a good example recently. In March 2025, the German government announced €500bn in additional borrowing over the coming years to renew the run-down infrastructure across the country. This (debt-funded) programme is financed by a separate fund that is outside the core annual (tax-funded) budget.
Although the government pledged to use the €500bn in borrowing only for spending on infrastructure investment (good!), experts at the Institute for the German Economy (IW) find that much of this spending effectively replaces investment that would have been financed from the original budget anyway (9). This frees up space in the core budget for more day-to-day (consumptive) spending, rather than increasing total investment. Consequently, more consumptive spending comes at the cost of higher deficits, which is the opposite of sustainable. The price will be paid by future generations who will have to repay the additional debt without benefiting from the spending it financed. This is neither fair nor sustainable.
Conclusion
Government debt can be something extremely useful: it allows governments to forcefully respond to economic crises without undermining their very policy objective through higher taxes. However, as public debt levels rise, interest payments take up a larger share of the budget, causing constraints because less of the government budget is left for consumption and investment. The difficult decisions by UK Chancellor Rachel Reeves in her budgets underlined the trade-offs that high public debt brings: raising taxes calms markets and stabilises debt servicing costs but hurts growth. Not raising taxes does not hurt growth but worsens debt servicing costs, leaving less of the budget for consumption and investment. In both cases, the high public deficit continues to burden the economy.
New debt that is taken on in Europe should therefore primarily finance spending that enhances the economy’s productive capabilities, like sustainable infrastructure and education. This ensures that in the long term, interest payments can be covered by the returns that the (debt-funded) investments generate. Day-to-day consumptive spending, on the other hand, should not be financed at the cost of higher deficits. This particularly refers to Germany and its €500bn of additional borrowing. It is indispensable to use this additional debt only for returns-generating investments to ensure fiscal sustainability and intergenerational fairness.
Bibliography:
(1) Keynes, John Maynard. The General Theory of Employment Interest and Money / John Maynard Keynes. London: Macmillan, 1936. Print.
(2) Romer, Christina D. and David H. Romer (2010). The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks. American Economic Review, 100 (3): 763–801.
(9) Hentze, Tobias, 2025, Sondervermögen Infrastruktur und Klimaneutralität. Ein Verschiebebahnhof mit vielen Gleisen, IW-Kurzbericht, Nr. 92, Köln.
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