Chapter 16: Deficits, Surpluses, and Debt: Past, Present, and Future

1. Chapter 16:Deficits, Surpluses, and Debt: Past, Present, and Future By: Varanessa Dixon

2. Budgets and Budget Concepts Discretionary The government sets a spending limit annually Mandatory: Annual expenditure depends on how many people meet the requirements Net Budget Balance: The bottom-line; total receipts minus total outlays On-budget surplus: The surplus regarding the Non-Social Security portion of the unified budget Off-budget surplus: The surplus regarding the Social Security portion of the unified budget Note: Receipts > Outlays = Budget Surplus Receipts < Outlays = Budget Deficit Receipts = Outlays = Balanced Budget Federal Budget: A statement of income (receipts) and expenditures (outlays) for a specific period of time (a year). Unified Budget: The federal budget with Social Security included

3. Historical Budget Perspective • How to fix the budget is a: • Pocket Book Issue 3. Fairness Issue • Productivity and Economic-Growth Issue 4. International Issue 1998-2001: The federal government achieves a surplus in the unified budget 1960 1970 1980 1990 2000 2010 2020 1962-1997: Almost an unbroken string of budget deficits In 2001, tax cuts, a recession, and growing demands for money to fight terrorism depleted the surplus

4. Historical Budget Perspective: The Inclusion of Social Security • Figure 16.2 illustrates the differences between the On-Budget and the Unified Budget. • Including Social Security understates the budget, but only by a small portion

5. The Public Debt Gross Federal Debt: The debt of the federal government held by both the public and government agencies 2.7 Million Public Debt: The portion of the gross federal debt held by the public; the value of all government securities that have been sold to the public and are still outstanding 3.5 Million Public Debt is a major concern for businesses and financial markets because it effects the economy. 1962-1997: Growing period for public debt 1998-2001: Public debt fell due to the Treasury using the surpluses to redeem maturing securities

6. Burden of the Public Debt Smaller in 2001 than in 1962 due to increasing GDP and a shrinking deficit The public debt as a percentage of GDP Public Debt 100 X GDP

7. The Long-Run Budget and Debt Projections • The Congressional Budget Office (CBO) projected in 2001 a 10-year surplus. • September 11 and a recession caused the CBO to change their forecast to deficits from 2002-2005 and surpluses from 2006-2012 • CBO Projections from 2012-2075: • Tax policy will remain unchanged (including the expiration of the tax cut provision in 2001) • SS, Medicare and Medicaid, and Net interest are primary drivers of expenditures and will constrain other areas of the budget • There will be surpluses from 2006-2025. A negative budget balance will cause the deficit to grow as a percentage of GDP for the next 50 years

8. Measurement Issues Some economists say the federal budget deficits are overstated due to: • Inflation 2. Business Cycles Structural Deficit: The deficit at full employment Actual Deficit: The amount by which actual government expenditures exceed actual government revenues 3. Government Investment Consumption-type Expenditures: Food stamps and farm subsidies Investment-type Expenditures: Education, Research, and Highways Eliminate this portion 4. State and Local Government Deficits and Surpluses

9. Economic Effects of a Deficit Depends on the way a deficit is financed: -Public -Social Security -The Federal Reserve Deficits are desirable in recessions because the increase disposable income Deficits are desirable in recessions because the increase disposable income Increase in Output and Employment if the economy is at less than full-employment Increase in Output and Employment if the economy is at less than full-employment Increase in Output and Employment if the economy is at less than full-employment Keynesian View Keynesian View Modern View Modern View The Public: Expansionary, but by less than the Keynesians thought The Federal Reserve: No harmful effect to the deficit if the economy is operating at less than full-employment Social Security: Does not affect the budget due to no market transactions

10. Public and Federal Reserve Financing Effects Public Financing Demand for loanable funds (funds available for borrowing by households, firms, and government Interest Rates = S0 Interest Rate i1 Higher Interest rates lead to: Reduced investment Effect on Net Exports and Imports -Increased demand leads to dollar appreciation -Dollar appreciation= Decreased US Exports and Increased US Imports i0 D1 D0. D0. S0 D1. S1 Demand for and Supply of Loanable Funds Federal Reserve Increases the money supply causing demand to increase if the economy is operating at less than full-employment If the economy is operating at full-employment, the price level will increase, causing inflation to rise

11. The Burden of the Debt • Invalid Arguments About the Budget Deficits: • The federal government should be required to balance its budget annually. • The federal government should make the debt zero • The national debt is owed to ourselves • Burden to Tax Payers: • Burden on tax payers • If tax rates are high enough, incentives to work, save, invest, and innovate could be distorted

12. Taking Stock Establishing separate capital and operating budgets could lead to better deficit measurement Three Ways to Turn Surpluses From Social Security and On-Budget: • Using Them to Finance Public Debt • Finance Government Investment • Turn Them Into Tax Relief Future strains on the budget are showing up faster than the government can deal with