PUBLIC DEBT

June 2019, Paper-II
Question

Which of the following is not a method of debt of redemption?
a) Refunding b) Repudiation c) Sinking fund d) Capital levy
Answer B
 Public debt refers to loans incurred by the government to finance its activities when other sources of public income fail to meet the requirements.

 Redemption of debt refers to the repayment of a public loan. Although public debt should be paid, debt redemption is desirable too. In order to save the government from bankruptcy and to raise the confidence of lenders, the government has to redeem its debts from time to time. There are different methods of debt redemption, viz.;

 Refunding: Refunding of debt implies the issue of new bonds and securities for raising new loans in order to pay off the matured loans (i.e., old debts). When the government uses this method of refund, there is no liquidation of the money burden of public debt. Instead, the debt servicing (i.e., repayment of the interest along with the principal) burden gets accumulated on account of the postponement of the debt- repayment to save future debt.

 Conversion: By debt conversion, we mean reduction of interest burden by converting old but high interest-bearing loans into new but low interest-bearing loans. This method tends to reduce the burden of interest on the taxpayers. As the government is enabled to reduce the burden of debt which falls, it is not required to raise huge revenue through taxes to service the debt. Instead, the government can cut down the tax liability and provide relief to the taxpayers in the event of a reduction in the rate of interest payable on public debt. It is assumed that since most taxpayers are poor people while lenders are rich people, such conversion of public debt results in a less unequal distribution of income.

 Sinking Fund: One of the best methods of redemption of public debt is sinking funds. It is the fund into which a certain portion of revenue is put every year in such a way that it would be sufficient to pay off the debt from the fund at the time of maturity.

 Capital Levy: In times of war or emergencies, most governments follow the practice of raising the money necessary for the redemption of the public debt by imposing a special tax on capital. A capital levy is just like a wealth tax in as much as it is imposed on capital assets. This method has certain decisive advantages. Firstly, it enables a government to repay its (emergency) debt by collecting additional tax revenues from the rich people (i.e., people who have huge properties).

 Terminal Annuity: It is something similar to the sinking fund. Under this method, the government pays off its debt on the basis of the terminal annuity. By using this method, the government pays off the debt in equal annual installments.

 Repudiation of debt means simply that the government does not recognize its obligations and refuses to pay the interest as well as the principal. Repudiation is not paying off a loan but destroying it.