Deficit, Public Debt, and the Informal Economy

Define public deficit and public debt, and explain their relationship: why is the deficit said to be a flow and debt a stock? Use the analogy of the tap and the bath.

A state spends $10\,000\,000$ million pesos and receives revenue of $9\,400\,000$ million.

1. a) Calculate its annual deficit.
2. b) Explain where the state can get the difference from.

The figure shows the annual public deficit of an imaginary country over six years, as a percentage of GDP.

1. a) State in which years the state spent more than it received and in which years it saved.
2. b) Reason what happens to the country's total debt during those years even if the deficit is decreasing.

A country accumulates a debt of $20\,000\,000$ million pesos at an average interest rate of $3\ \%$.

1. a) Calculate annual interest expenditure.
2. b) Compare that figure with an education budget of $800\,000$ million and draw a conclusion about the "cost" of the debt.

During a budget debate, an analyst argues: "Public debt is an intergenerational scam: we are living beyond our means and condemning young people who have not even been born yet to pay the bill." In response, another economist states: "Public debt does not impoverish future generations because it is a debt that society owes to itself."

1. a) Critically evaluate both statements, distinguishing between debt held by residents and debt held by foreign creditors. In which case is there a true net transfer of wealth abroad in the future?
2. b) Imagine that one State issues $10,000$ million pesos in debt to finance an energy transition and digital infrastructure program, while another issues the same amount to cover the structural deficit of pensions and ministerial current spending. Using the intergenerational balance sheet (inherited assets versus liabilities), justify which of the two operations is sustainable and fair to future taxpayers.
3. c) Under what financial condition (relationship between the real interest rate on debt and GDP growth) can a high debt ratio stabilize without the need to implement immediate cuts or tax increases? Reason your answer.

Observe the budgetary data of a country during the first year of an economic recession:

• Real GDP falls by $3.2\,\%$.

• Tax revenue (personal income tax and VAT) decreases from $120,000$ to $106,000$ million pesos.

• Spending on unemployment benefits increases from $14,000$ to $21,000$ million pesos.

• The remaining public spending items remain frozen at $110,000$ million pesos.

• The Government has not passed any tax laws or discretionary budgetary changes.

1. a) Demonstrate, using these data, how the automatic stabilizers have operated and calculate the change in the budget balance (deficit or surplus). What macroeconomic function do they serve regarding aggregate demand during the fall in GDP?
2. b) Suppose that the Minister of Finance, alarmed by the resulting deficit, decides to implement a procyclical policy by cutting public spending on healthcare and infrastructure to force an immediate budget balance. Predict the impact this decision will have on GDP, unemployment, and future tax revenue (paradox of thrift / paradox of austerity).
3. c) Distinguish between cyclical deficit and structural deficit in this scenario. Why can trying to eliminate the cyclical deficit through spending cuts worsen the crisis?

Explain what the shadow economy is and classify these situations depending on whether or not they belong to it: a plumber who charges cash without an invoice to avoid declaring it, a teenager who babysits their brother without pay, and a street vendor working without a license and without declaring income.

Analyse the causes and consequences of the shadow economy: why it arises (taxes, paperwork, habit) and what effects it has on tax revenue, business competition, and informal workers themselves.

A municipal report reveals that in a tourist town, $25\,\%$ of home renovation work and hospitality services is paid in cash without being declared. The spokesperson of a merchant association states: "In reality, this benefits the town: the client saves $21\,\%$ in VAT, the self-employed worker survives with lower costs, and that money is spent in local shops, boosting the economy."

1. a) Refute this argument from an economic standpoint: demonstrate what negative externalities and failures this practice generates regarding the sustainability of the welfare state, public accounts, and businesses operating legally.
2. b) One political party proposes reducing the shadow economy by lowering general tax rates, while another proposes tripling inspections and penalties. Predict the effects of both measures on the public deficit and tax compliance in the short and long term.
3. c) Design a fiscal measure based on conflicting interests between buyer and seller to bring undeclared activity to light voluntarily, justifying its feasibility.