Transcript Chapter 14 – Miller

Chapter 14 – Miller
Deficit Spending and Public Debt
Did You Know That...
 The U.S. federal government spends
a total of more than $3 billion per day
on Social Security, Medicare, and
Medicaid.
 Each of these guaranteed spending
programs is individually nearly as
large as the entire discretionary
portion of the federal government’s
budget.
Terms to Know
Automatic fiscal policy
a change in fiscal policy caused by the
state of the economy
Discretionary fiscal policy
a policy action initiated by an Act of
Congress
Expansionary fiscal policy
government should either increase its
purchases of g&s or cut its taxes. (this
obviously will increase the budget deficit
because in order to fund the expansion…
government will have to borrow funds
from private sources).
Public Deficits and Debts:
Flows versus Stocks
 Government Budget Deficit
 Exists if the government spends more
than it receives in taxes during a given
period of time
 Is financed by the selling of government
securities (bonds)
Public Deficits and Debts:
 The federal deficit is defined for a
specific period of time, usually one
year. Fiscal year begins October 1st
 If spending equals receipts, the
budget is balanced.
 If receipts exceed spending, the
government is running a budget
surplus.
Figure 14-1 Federal Budget
Deficits and Surpluses Since
1940
*Budgeted items not including 2008–2009 financial institutions bailout expenditures.
Source: Office of Management and Budget.
Figure 14-2 The Federal Budget
Deficit Expressed as a
Percentage of GDP
*Budgeted items not including 2008–2009 financial institutions bailout expenditures.
Sources: Economic Report of the President; Economic Indicators, various issues.
Government Finance: Spending More
than Tax Collections (cont'd)
 Question
 Why has the government’s budget
recently slipped from a surplus of 2.5%
of GDP into a deficit?
 Answer
 Spending has increased at a faster page
since the early 2000s than during any
other decade since WWII.
 Recent income, capital gains, and estate
tax cuts
Ownership of the Debt
Total public debt can be divided into
proportion held by the public (57%)
latest figures… and 43% by federal
agencies and Federal Reserve.
Evaluating the Rising
Public Debt (cont'd)
 Tax revenues tend to be stagnant
during times of slow economic
growth.
 Tax revenues grow more quickly
when overall growth enhances
incomes.
 As long as spending exceeds
revenues, the budget deficit will
persist.
2007 Tax Breakdown - Incomes
% Income
Income _AGI
% Taxes Paid
Top 1%
$410,096
40.42%
Top 5%
$160,041
60.63%
Top 10%
$113,013
71.22%
Top 25%
$66,532
86.59
Top 50%
$32,879
97.11
Bottom 50%
$32,879
2.89%
Evaluating the Rising
Public Debt (cont'd)
 The government must pay interest on
the public debt outstanding.
 The level of these payments depends
on the market interest rate.
 Interest payments as a percentage of
GDP are likely to rise in the future.
Evaluating the Rising
Public Debt (cont'd)
 If the economy is already at full
employment, then further provision of
government goods will crowd out
some private goods.
 Deficit spending may raise interest
rates, which in turn will discourage
capital formation in the private
sector.
Evaluating the Rising
Public Debt (cont'd)
 Crowding-out may place a burden on
future generations.
 Increased present consumption may
crowd out investment and reduce the
growth of capital goods—which could
reduce a future generation’s wealth.
 Taxes may have to be increased;
imposing higher taxes on future
generations in order to retire the debt.
Federal Budget Deficits
in an Open Economy (cont'd)
 We know what a budget deficit is, but
a trade deficit exists when the value
of imports exceeds the value of
exports.
 Some say it appears that there is a
relationship between trade and
budget deficits; at least there is a
statistical correlation between the
two.
The Related U.S. Deficits
Sources: Economic Report of the President; Economic Indicators, various issues;
author’s estimates.
Federal Budget Deficits
in an Open Economy (cont'd)
 If foreigners are using the dollars
they hold to buy U.S. government
bonds, then they will have fewer
dollars to spend on U.S. exports.
 This shows that a U.S. budget deficit
can contribute to a trade deficit.
Growing U.S. Government Deficits:
Implications for U.S. Economic
Performance (cont'd)
 In the long run, higher
government budget deficits have
no effect on equilibrium real GDP.
 Ultimately, spending in excess of
receipts redistributes a larger
share of real GDP to governmentprovided goods and services.
Growing U.S. Government Deficits:
Implications for U.S. Economic
Performance (cont'd)
 Thus, if the government operates
with higher deficits over an extended
period
 The ultimate result is a shrinkage in
the share of privately produced goods
and services
 By continually spending more than it
collects, the government takes up a
larger portion of economic activity.
Policy Example: A Short-Run Deficit
Boosting Stimulus is Set to Give Way to
Deficit-Fighting Tax Increases
 In early 2008, Congress passed the
Economic Stimulus Act in response to
declining GDP growth rate.
 This law provided for $45 billion in
government spending and authorized
tax “rebates” aimed at stimulating
consumptions pending and preventing
a short-run recessionary gap from
expanding.
Policy Example: A Short-Run Deficit Boosting
Stimulus is Set to Give Way to Deficit-Fighting
Tax Increases (cont'd)
 However, worries over an increasing
budget deficit prompted Congress to
authorize a significant personal
income tax increase at the end of
2010. (was extended to 2012)
 This rate will raise the overall U.S.
personal income tax burden by 25%.
 Higher tax rates could reduce longrun aggregate supply and dampen
future real GDP growth.
Growing U.S. Government Deficits:
Implications for U.S. Economic
Performance
 How could the government reduce its
red ink?
 Increasing taxes for everyone
 Taxing only the rich
 Reducing expenditures
 Whittling away at entitlements
Growing U.S. Government Deficits:
Implications for U.S. Economic
Performance (cont'd)
 In considering how expenditures
might be reduced, it is important to
look at entitlements.
 These are federal government
payments that are legislated
obligations and cannot be reduced or
eliminated.
Growing U.S. Government Deficits:
Implications for U.S. Economic
Performance (cont'd)
 Entitlements are the largest
component of the U.S. federal
budget.
 To make a significant cut in
expenditures, entitlement programs
would have to be revised.
Stay Tuned…..