5 Ways Governments Reduce National Debt

While reducing debt and stimulating the economy are common goals of most governments in developed economies, achieving those objectives often involves tactics that appear to be mutually exclusive and sometimes contradictory. Given the myriad of fiscal and monetary policies, individuals and economists commonly debate strategies to reduce the national debt.

1. Bonds

Using Debt to Pay Debt

Governments issue bonds to borrow money to avoid raising taxes. This helps pay expenditures and stimulate the economy through public spending. The government must pay interest to its creditors with debt issues.

Theoretically, spending can generate additional tax income from businesses and taxpayers, which can be used to pay down debt. Issuing debt may provide a boost to economic growth but may not be effective in reducing long-term government debt directly.

Buying Back Bonds

When the economy struggles, as during periods of high unemployment, governments seek to stimulate the economy by buying bonds they have issued. The U.S. Federal Reserve implemented quantitative easing, buying government bonds and other financial securities to spur economic growth and aid recovery from the financial crisis of 2007-2008.Many financial experts favor a quantitative-easing tactic in the short term. However, buying debt has not proved more effective than borrowing one's way to prosperity by issuing bonds.

2. Interest Rates

Maintaining interest rates at low levels can help stimulate the economy, generate tax revenue, and, ultimately, reduce the national debt. Lower interest rates make it easier for individuals and businesses to borrow money for goods and services, which creates jobs and increases tax revenues. Low interest rates have been used as a strategy of the United States, the European Union (EU), the United Kingdom, and other nations during times of economic stress.

3. Spending Cuts

From 1921 to 1974, the President led the government budgeting process. In 1974, President Nixon signed the Budget and Impoundment Control Act of 1974 so that Congress could reclaim power over spending. Each year, the Congressional Budget Office (CBO) publishes the long-term projections of the federal budget and the future economy based on a current snapshot.

Citizens often waver in opinions about the need to balance the budget or cut government spending. These cuts often culminate in reductions in benefits to low-income families, veterans programs, and environmental protection programs.

4. Raising Taxes

Governments can raise taxes to pay for expenditures and to pay down their debt. Taxes can include federal, state, and in some cases, local income and business tax. Other tax examples include the alternative minimum tax, "sin" taxes on alcohol and tobacco products, corporate tax, estate tax, Federal Insurance Contributions Act (FICA), and property taxes.

Although tax hikes are common practice, most nations face sizable and growing debts. When cash flows increase but spending continues to rise, increased revenues have little impact on a nation's overall debt level.

5. Bailout or Default

Many nations in Africa have been the beneficiaries of debt forgiveness. In the late 1980s, Ghana's debt burden was significantly reduced by debt forgiveness. To avoid default in 2010, Greece was given the equivalent of $146 billion in bailout funds by the International Monetary Fund and the European Union.

Default can include bankruptcy and/or restructuring payments to creditors, which is a common and often successful strategy for debt reduction.

The Bottom Line

Governments use various strategies to reduce their national debts. From issuing debt in the form of bonds to lowering interest rates, such actions may have short-lived success but always encounter debate.