Advantages and disadvantages of debt financing over taxation

Advantages (Merits) of Debt financing over Taxation financing

1. Debt financing has a wider source of rising government revenue as compared to taxation. Unlike taxation which is limited to one country in mobilizing and rising financial resources, borrowing enables the country to raise revenue from internal and external
2. Borrowing reduces the negative effects of taxation such as reduced investments, low aggregate demand, reduced savings etc. which are associated taxation
3. Borrowing is the more reliable and quicker source of rising government revenue. It is not associated with tax evasion and avoidance which makes tax revenue highly unreliable for government planning and
4. In case of a narrow tax base, borrowing acts as a suitable alternative for rising government revenue
5. Borrowing can be used to raise government revenue in case of political instabilities and other emergences like earth quakes, floods, epidemics
6. Unlike taxation, borrowing limits political resistance and unrest in an economy which is mainly caused by high tax burdens imposed on the people in form of paying
7. Unlike taxation, borrowing tends to be regressive in nature especially the indirect taxes. This greatly affects the poor so much and also widens the income gap between the rich and the poor. This is true with indirect taxes imposed on consumer commodities e.g. salt, sugar
8. Unlike taxation, borrowing improves on the country’s relationship with other countries and international organizations like IMF and World Bank. This promotes international co-operation and friend ship.
9. Unlike taxation, external borrowing is a major source of foreign exchange which is scarce in the economy like Uganda. This is mainly used to import commodities (consumer and capital goods) which cannot be produced locally.
10. Unlike taxation, borrowing is associated with a lower degree of corruption and embezzlement of government revenue. There is a high degree of corruption during tax assessments, administration collection which lowers the revenue under taxation financing.
11. Unlike taxation, borrowing helps in deficit financing in case revenue is inadequate to finance government expenditure.

Demerits of Debt financing (Borrowing)

1. It promotes external dependence syndrome. This undermines the country’s need to become self-reliant and self-sustaining.
2. It leads to inflation in case of external borrowing. This is because it increases money supply and aggregate demand in the economy hence demand pull inflation.
3. It worsens the Balance of payment position of the country. This is because it involves capital out flow in form of debt
4. It increases the debt burden on the current and future generation. The current generation foregoes consumption and the future generation suffers the burden of debt payment.
5. It increases political and economic dominance of the economy by the lenders. The lenders can influence the social economic policies carried out in their favor even if they are not in line with the needs of the people.
6. Borrowing increases  income  inequalities  among  people  .This  is  true  especially  when  the borrowed funds are used to develop one region or misused through corruption to benefit a few individuals.
7. It limits capital accumulation and investment. This can occur when the borrowed funds are used to service the debts contracted in the past or to finance the recurrent expenditure of the government.
8. It does not promote a sense of civic responsibility among the citizens towards nation building. This is because the citizens do not contribute to the government revenue and therefore they are not concerned how the government allocates the borrowed funds.