Public savings refer government’s money left after paying all spending. Or, it equals to revenue (tax revenue) minus government spending. Also called government savings.
Positive public savings (fiscal surplus) is when tax revenue exceeds expenditure, and it is negative (fiscal deficit) when tax revenue is lower than expenditure.
What is the difference between public and private savings?
As its name, public savings come from public sectors, i.e., government. Meanwhile, private savings come from private sectors, i.e., the sum of household savings and business savings.
Private savings are the difference between government revenue and expenditure. Because a large portion of government revenue comes from taxes, in textbooks, some authors use tax revenues to represent total government revenues.
Public savings = Tax revenue – Government expenditures
As the primary source, tax revenue depends on several factors, including the number of taxpayers, household income, business profits, international trade activities, and so on. In short, taxes depend on economic activity and the overall level of health of the economy.
On the other hand, government spending is one of the drivers of economic growth. The government uses taxes to finance expenditures, including current consumption (such as personnel and equipment expenditure), transfer payments, and capital expenditure (such as infrastructure development). Government expenditure is part of aggregate income and is included in the calculation of Gross Domestic Product (GDP).
When tax revenue exceeds expenditure, the government runs a budget surplus. This surplus represents public savings.
However, when tax revenues are lower than spending, the government experiences a fiscal deficit. And, public savings are negative (dissaving).
Deficits might occur because the government is building infrastructure on a large scale. Such projects consume more money than what can be financed through taxes. To finance the deficit, the government owes, mainly by issuing the debt securities.
Public savings and crowding out effect
National savings represent the domestic supply of loanable funds in the economy. When the government runs a budget deficit, it reduces the supply of loanable funds to the private sector (business and households).
Declined supply of loanable funds raises the cost of money (interest rate), leading to more expensive borrowing costs.
Rising interest rates weaken demand from a new loan by the private sector. Because it is more costly, households tend to be reluctant to apply for new loans. Likewise, companies prefer to delay capital assets purchase because rising investment costs make it unprofitable.
The impact of the government deficit on decreasing business investment is called crowding out.
When a fall in business investment is more significant than the effect of a budget deficit, this can reduce the economic growth rate.
Positive government savings have the opposite effect. A fiscal surplus increases the supply of loanable funds, driving down interest rates in the financial market. The government can use the excess to redeem a portion of the high-cost debts.
For private sectors, low-interest rates stimulate business investment and household spending, which in turn drives the economy to grow.