Where Public Money Goes

A national budget can look like an unreadable wall of numbers. Underneath, it answers three questions: what will the state spend on, how will it raise the money, and what happens to the difference? This piece explains each one, then hands you the controls. To stay neutral, the country in the simulator is fictional and its starting numbers are round illustrations, not any real nation's accounts.

Who holds the purse

In almost every democracy, the executive proposes the budget and the legislature must approve it. This "power of the purse" is one of the oldest checks on rulers: England's Bill of Rights of 1689 declared it illegal for the Crown to levy taxes without Parliament's consent, and "no taxation without representation" became a rallying cry of the American Revolution. When legislatures and executives can't agree, some systems keep money flowing on a provisional basis until a deal is reached; in others, such as the United States, parts of the government can shut down.

Where the money goes

Governments in rich countries now spend far more than they once did. In the late 19th century, European governments spent roughly a tenth of national income; today the figure is closer to half in many European countries. Most of that growth went to social protection and health, which together take about half of all government spending across OECD countries on average, with pensions and old-age support the single largest item.

A useful distinction: much spending is effectively automatic. Pension and benefit rules, once set in law, pay out to everyone who qualifies, year after year, unless the law changes. That leaves a smaller "discretionary" slice that lawmakers actually argue over each year.

Where the money comes from

Most government revenue comes from a handful of taxes: income taxes on people, social-security contributions on wages, consumption taxes such as VAT or sales tax, corporate taxes on company profits, and property taxes. Countries mix them very differently. Poorer countries typically collect much less: World Bank data put tax revenue in low-income economies at around a tenth of GDP, partly because so much work happens in the informal economy, where taxes are hard to collect.

Two ideas help when you hear tax arguments. A tax is progressive if richer people pay a larger share of their income, regressive if poorer people do, and flat if everyone pays the same share. And the person who hands over the money isn't always the one who bears the cost: a tax on companies may be paid partly by their workers, customers or shareholders. Economists call this tax incidence, and it is often genuinely uncertain.

A deficit is one year's gap. Debt is all the past gaps added up, plus the interest on them.

Run the budget of Examplia

Examplia's economy produces 1,000 coins a year, and it already owes 600 (debt of 60% of GDP). All numbers are shares of GDP. Choose a preset or move the sliders, then look at the ten-year debt path.

Three things to try. First, make the budget balance exactly zero before interest (spending equal to revenue) and watch debt as a share of GDP still drift: whether it rises or falls depends on whether the interest rate is above or below the growth rate. Second, raise the interest rate to 6% and leave everything else alone. Third, find the smallest change that keeps debt steady. The box under the chart tells you the target.

Why "debt" isn't simply good or bad

Governments are not quite like households. They don't retire, so they can roll debt over indefinitely; their income (the tax base) grows with the economy; and many borrow in a currency their own central bank issues. That's why debt measured against the size of the economy matters more than the raw total, and why borrowing to get through a recession or a war, or to build things that raise future growth, can make sense.

But there are real limits. Interest has to be paid before anything else, so a heavily indebted state has less room for schools or hospitals, especially if rates rise. Lenders can lose confidence suddenly, pushing rates up just when the government needs them low. Countries that borrow in a foreign currency have defaulted, and some that financed spending by printing money have suffered runaway inflation. Where the safe level of debt lies is one of economics' most argued questions, and the honest answer is that it depends on the country, its currency, its growth and who its lenders are.

The values underneath

The simulator can tell you the arithmetic, not the right answer. People who favour a smaller state argue that lower taxes leave more money and freedom with the people who earned it, encourage work and investment, and limit what governments can do badly. People who favour a larger state argue that shared provision of health, education and security in old age is more efficient and fairer than leaving people to fend for themselves, and that markets alone underprovide public goods. Both camps can point to prosperous democracies that chose their way. (See The Political Spectrum, Fairly Presented, in this library.)