Weaknesses in the government's strategy for managing personal debt is raising costs to the taxpayer, according to the National Audit Office.
Struggling to pay debts makes people more likely to end up in state-subsidised housing, the body says.
It also leads to anxiety and depression, which adds to NHS costs.
But the government has a "limited" understanding of the impact of debt, and there was a lack of co-ordination between departments, the NAO said.
"Problem debt has significant consequences both for individuals and the taxpayer," said Amyas Morse, the head of the NAO.
The government's attempts to address the issue so far had been "insufficient", he added.
Funding pressures might also be leading to debts being pursued "too quickly and aggressively" the NAO said, thus exacerbating their impact.
The NAO said its modelling estimates suggested that "intimidating actions and additional charges" for those in debt increased the likelihood of mental health problems.
There are 8.3 million people struggling with personal debt in the UK, it said.
Problem debts to government, largely over council tax or benefits, have become the biggest issue reported to Citizens Advice in the last five years.
The NAO estimates the cost of problem debts to the taxpayer as follows:
- Increased use of social housing - £225m
- Increased use of NHS services - £24m
But it adds that the wider costs to the economy of problem debts, such as increased dependency on a wide range of public services, informal care, and lost employment, run to £900m.
Frank Field MP, chairman of the Work and Pensions Select Committee, said the level of private debt owed to government was "a sorry indictment of the benefits policy".
Lower earning families are being locked "into a miserable cycle of debt and hunger, easy prey to loan sharks and forced to resort to food banks", he added.
An HM Treasury Spokesperson said it was taking action on problem debt: "We're increasing funding for the Money Advice Service to over £56m enough to help over 530,000 people get the debt advice they need.
"We're also introducing a breathing space from problem debt to give people time to get their lives back on track."
HM Treasury has formal responsibility for managing these debts, but the NAO says it has limited information, does not fully understand the problem, and cannot respond effectively.
Amyas Morse, the head of the NAO, said: "The Treasury needs a better understanding of the scale of people's debt problems and how it is impacting their lives and the taxpayer so it can effectively resolve the problem."
Joanna Elson OBE, chief executive of the Money Advice Trust, the charity that runs National Debtline, said: "We need to see a new cross-government strategy to tackle problem debt - which brings together the work of government departments, agencies and regulators into a single, coherent approach.
The NAO says the way government bodies try to collect debts can end up being counter-productive.
It said its analysis had found that "intimidating actions and additional charges" were 15% to 29% "more likely to make debts harder to manage and increase levels of anxiety or depression."
"We found examples of good practice, but it is not adopted consistently.
"For example, established best practice in how to assess the affordability of repayments, promoted by The Money Advice Service, is used by only 19% of local authorities and is not used as standard by government departments," it added.
Research by the debt charity StepChange found that more people felt they were treated unfairly by local authorities than by payday lenders. Treating debtors fairly, it estimated, could lead to creditors saving an average of £730 per person.
StepChange CEO Phil Andrew said: "The National Audit Office hits the nail on the head.
"Poor debt collection practices that fixate only on getting as much money back as quickly as possible are counter-productive and ultimately harmful.
"The government is simply robbing Peter to pay Paul, as the wider implications of government debt collection practices are costing taxpayers almost a quarter of a billion pounds every year."