Chapter 12 Federal Deficits, Surpluses, and the National Debt

1. Chapter 12Federal Deficits, Surpluses, and the National Debt

2. Chapter Outline • Surpluses, Deficits, and the Debt: Definition and History • How Economists See the Debt • Who Owns the Debt • A Balanced Budget Amendment • Projections of the Future

3. Surpluses, Deficits, and the Debt: Definitions • Budget Deficit: the amount by which expenditures exceed revenues • Budget Surplus: the amount by which revenues exceed expenditures • National Debt: the total amount owed by the federal government

4. Off vs. On Budget • Off-budget: parts of the budget designated by Congress as separate from the normal budget. Programs that operate with their own revenue sources and have trust funds; Social Security, Medicare, and the Post Office are examples. • On-budget: parts of the budget that rely entirely or mostly on general revenue.

5. History of Deficits, Surpluses, and the National Debt • Revolutionary War debt $75 million • Closest budget to balance (no deficit or surplus) was $3800 in 1835 • There were more years of surplus than deficit between 1791 and 1836 resulting in a national debt of only $37,000 • Civil War debt reached $2 billion • From 1865 to 1930 the debt reached $50 billion • By 1946 (the end of WWII) the debt was $250 billion • By 2009 the debt was $13 trillion

6. Accounting for Inflation • All figures for deficits, surpluses, and the national debt must be adjusted for inflation • The Real Deficit or Real Surplus measures the deficit or surplus in constant dollars

7. Real Deficit/Surplus

8. Debt and the Ability to Pay It • Economists insist that the absolute magnitude of the debt is less important than a nation’s ability to pay it. • The measure that does this is the Deficit/GDP ratio

9. Deficit/GDP

10. Surpluses of the late 1990s • Surpluses were generated over the late 1990s as a result of • High GDP growth that resulted in high tax revenues • Peace Dividend: money that was freed up for other spending priorities when the Cold War was over • Rapid increases in capital gains tax revenue from a booming stock market

11. How Economists See the Deficit and Debt • Separating the Operating and Capital Budgets • Operating Budget: part of the federal budget devoted to spending on goods and services that will be used in the current year • Capital Budget: part of the federal budget devoted to spending on goods that will last several years • Separating Cyclical and Structural Deficits • Cyclical Deficit: That part of the deficit attributable to the economy’s not being at full employment • Structural Deficit: That part of the deficit that would remain even if the economy were at full employment • Functional Finance: that part of the deficit attributable to the “stimulus package” useful and label it functional finance.

12. The Debt as a Percentage of GDP

13. International Comparisons Debt as a % of GDP

14. Generational Accounting • A method of analysis that computes a net tax rate that accounts for the taxes that each generation will pay compared to the services and transfers they will receive. • If government runs a deficit in one generation to finance a project where the benefits accrue to a later generation that is paying the interest on that debt then the net tax rate does not change.

15. Who Owns The Debt • Public • US investors • Foreign investors • Trust Funds • Social Security • Medicare • Federal Reserve • The Fed buys Federal Debt as a means of getting new money into the money supply.

16. Who Holds Federal Debt

17. Externally Held Debt

18. A Balance Budget Amendment • Proponents argue that a BBA is necessary to keep a current generation from borrowing more than is optimal. • A majority of economists do not favor such an amendment because it would be Procyclical • good times would be even better and bad times even worse

19. Price Level Price Level AS AS AD1 AD2 AD3 AD1 AD3 AD2 RGDP RGDP Figure 5 Built-In Stabilizers

20. Projections for the Future • The Office of Management and Budget (in the White House) and the Congressional Budget Office each produce a projection of the 10 year budget picture using assumptions of economic growth. • These projections are rarely accurate beyond the near term because • They often are based on the assumption that Congress will not change current law. • They are quite sensitive to small changes in the performance of the economy.

21. CBO Projections