Debt and taxes

Government debt is a less reliable explanation for bond yields than the business cycle, while the size of government revealed by tax and spending rates can materially affect economic performance.

• Fiscal concerns span high-tax France, low-tax America and Spain, which has not approved a budget since 2022; the UK’s tax rate has returned to 1970s levels.
• Although higher taxes generally reduce debt when other conditions are equal, spending and revenue gaps are usually small compared with the overall scale of government, so debt levels can diverge from public-sector size: the US combines a relatively small government with high debt, while Norway shows the opposite pattern.
• The author argues that the recent rise in bond yields should not mainly be attributed to government borrowing, because no durable relationship between debt and yields is visible across time or countries; inflation and growth provide the stronger observable link.
• Public provision remains necessary for law, defence, utilities and social protection, but the appropriate balance between public and private activity is uncertain, and the UK’s fiscal rules do not regulate overall tax or spending rates.
• The author records a personal shift from dismissing arguments about tax disincentives and safety-net effects to accepting them, while Mario Draghi’s 2024 report links regulatory burdens and larger governments to Europe’s weak competitiveness.

Takeaway: Investors should look beyond deficit and debt headlines and consider how the scale and design of government affect growth, competitiveness and markets, while recognising that no simple rule defines the optimal public-private mix.