By Ramil Abbasov (05/05/2025)

When governments find themselves with budget surpluses—where revenues exceed expenditures—they’re often met with a rare but critical question: What now?

The temptation is strong to spend it all—perhaps on new public programs, flashy infrastructure projects, or election-season tax cuts. After all, public pressure tends to mount when citizens hear there's "extra" money in the national coffers. Yet history, economic theory, and global examples point to a wiser, more sustainable choice: using surpluses to reduce public debt.

This may not be the most glamorous option, but it is among the most impactful. Lowering debt can cut future interest payments, strengthen credit ratings, and give governments the fiscal space to respond to future crises. It’s a move that trades short-term popularity for long-term prosperity.

Why Debt Reduction Matters

In periods of economic expansion, running a budget surplus provides a rare chance to improve the fiscal foundation of a country. High debt-to-GDP ratios, while manageable in some cases, generally lead to higher borrowing costs and reduced investor confidence. According to studies by economists Carmen Reinhart and Kenneth Rogoff, when public debt crosses certain thresholds, it tends to slow economic growth. While those thresholds may not be ironclad, the risk is clear: unsustainable debt levels can leave economies vulnerable.

Consider the interest burden alone. Every dollar spent servicing debt is a dollar not spent on healthcare, education, or infrastructure. Reducing this burden can free up resources for the future, especially when interest rates rise.

Examples from Around the Globe

Let’s look at what history teaches us.

Between 1998 and 2001, the United States enjoyed a rare period of budget surpluses. Rather than immediately expanding spending, the government used these surpluses to retire $453 billion in federal debt. This move helped reduce the debt-to-GDP ratio and created breathing room for future fiscal challenges.

Norway offers another compelling case. Thanks to oil revenues, the Norwegian government often runs surpluses. But rather than spend them domestically, they invest them into the Government Pension Fund Global—a sovereign wealth fund valued at over a trillion dollars. This strategic use of surpluses helps stabilize the economy, prepare for demographic shifts, and promote intergenerational fairness.

Australia’s recent return to surplus after the COVID-19 pandemic also demonstrates responsible fiscal governance. Instead of rushing to launch new spending programs, the Australian government focused on paying down debt, strengthening its economic buffers, and maintaining room for future emergency spending.

Theoretical Backing for Surplus-Driven Debt Reduction

Economic theory supports this cautious approach. Neoclassical models, such as those developed by Robert Barro, argue that persistent deficits can crowd out private investment and lower long-term growth. Conversely, surpluses used for debt reduction can raise national savings, reduce distortionary taxes in the future, and increase investor confidence.

Public finance principles like the intertemporal budget constraint suggest that governments must eventually balance spending and revenues over time. Surpluses today can help offset deficits during economic downturns. As Olivier Blanchard points out, maintaining a healthy primary balance is key to managing public finances, especially when economic growth does not outpace interest rates.

Keynesian economists add nuance: they caution against surplus-driven austerity during recessions, as it can suppress demand and worsen downturns. However, they generally support the use of surpluses for debt reduction during boom periods. Timing, in other words, is everything.

The Political Economy of Surpluses

Despite the economic logic, political incentives often favor immediate spending. Voters may prefer visible tax cuts or new services over the abstract benefits of lower national debt. Politicians, working within short electoral cycles, may lack the incentive to prioritize long-term fiscal health.

This is where institutions matter. Countries with strong, independent fiscal councils, transparent budgeting processes, and legally binding rules are better equipped to resist short-term pressures. They can help channel surpluses toward sustainable uses, ensuring future generations benefit from today’s good fortune.

Public choice theory highlights this dilemma: rational voters and politicians may act in their own short-term interest, even if the collective long-term cost is high. That’s why rules-based frameworks—like Sweden’s surplus target or the European Union’s Stability and Growth Pact—play a crucial role in encouraging fiscal responsibility.

Balancing Priorities: Debt vs. Investment

To be sure, debt reduction isn’t always the optimal use of surpluses. If a country’s infrastructure is crumbling, or if investments in education and technology could yield high long-term returns, then spending may be justified. The key lies in comparing the expected return on investment to the interest rate on public debt.

Some economists, particularly from the endogenous growth school, argue that well-targeted public investment can have a higher payoff than simple debt repayment. In such cases, using a portion of surpluses for strategic investments—alongside modest debt reduction—might be the best path.

This doesn’t mean splurging. It means spending smart. Performance-based budgeting systems, which link spending to outcomes, can help ensure that any investments made with surplus funds deliver real value.

Policy Recommendations for Surplus Use

For policymakers, the first step is recognizing that surpluses are both rare and valuable. They shouldn’t be treated as blank checks for political wish lists.

Instead, governments should develop clear frameworks for surplus allocation. This might include rules that prioritize debt reduction up to a target level, followed by investments in infrastructure, education, or sovereign wealth funds. Transparency and public engagement are essential to maintain trust and accountability.

Second, institutional safeguards can prevent the misuse of surpluses. Fiscal councils, independent oversight bodies, and binding budget rules help depoliticize surplus allocation and align decisions with long-term economic goals.

Finally, communication matters. Politicians must explain why using a surplus to pay down debt benefits the public. Reduced interest payments mean more funds for future priorities. Stronger public finances mean less vulnerability during crises. And a credible fiscal strategy promotes confidence among investors and citizens alike.

Looking Ahead: A Moment of Choice

As global economies recover from the shocks of COVID-19, some are fortunate enough to be in surplus territory again. This presents a moment of choice. Do we repeat the mistakes of the past, allowing surpluses to fuel short-term spending sprees? Or do we learn from success stories and invest in our future stability?

Debt reduction is not glamorous, but it is powerful. It reflects prudence, responsibility, and care for the next generation. In a world rife with uncertainty—from climate change to geopolitical tensions—building fiscal resilience is not just wise. It’s essential.

Surpluses are a gift. Let’s not waste them.

Ramil Abbasov is a climate change and sustainability expert with over 14 years of experience in public finance management, climate finance, greenhouse gas emissions accounting, policy research, and economic analysis. He has worked closely with international organizations—including the United Nations Development Programme and the Asian Development Bank—to integrate climate risk assessments and mitigation strategies into financial governance frameworks.

Currently, Ramil serves as a Research Assistant at George Mason University, contributing to the NSF-funded Community-Responsive Electrified and Adaptive Transit Ecosystem (CREATE) project through quantitative data analysis and stakeholder engagement initiatives. Previously, he held key roles at the Asian Development Bank in Baku, Azerbaijan, where he excelled as both the National Green Budget Economy Expert and the National Public Finance Management Expert, driving efforts in climate budget tagging, green economy analysis, and sustainable development policy integration.

In addition to his work with multilateral institutions, Ramil is the CEO and Founder of “Spektr” Center for Research and Development, a research organization focused on advancing climate finance, energy transition, and sustainable economic policies. His earlier career includes leadership positions such as Director at ZE-Tronics CJSC and managerial roles in the banking sector with AccessBank CJSC and retail management with Third Eye Communications in the USA.