Transcript Chap32
Chapter 32
Federal Budgets
and Public Policy
© 2006 Thomson/South-Western
1
Federal Budget Process
The federal budget is a plan for
government outlays and revenues for a
specified period, usually a year
Federal outlays include both
Government purchases
Transfer payments
2
Exhibit 1: Defense’s Share of Federal Outlays
Declined Since 1960 and Redistribution Increased
3
President’s Role in Budget Process
President’s budget process usually begins
a year before it is submitted to Congress
The congressional budget cycle begins in
late January once Congress gets The
Budget of the United States Government
from the president
4
Congressional Role in the Budget Process
Once the president’s proposed budget gets to
Congress, budget committees in both the House
and the Senate rework until they agree on total
outlays, spending by major category, and expected
revenues
This agreement, called a budget resolution,
establishes a framework to guide spending and
revenue decisions
The fiscal year runs from October 1 of one year to
September 30 of the following year
5
The Budget
The size and composition of the budget and the
difference between outlays and revenues
measure the budget’s fiscal impact
When outlays exceed revenues, the budget is in
deficit
Stimulates aggregate demand in the short run, but
reduces national saving that in the long run could
impede economic growth
When revenues exceed outlays, the budget is in
surplus
Dampens aggregate demand in the short run, but
enhances domestic saving that in the long run could
promote economic growth
6
Problems with the Federal Budget Process
Continuing Resolutions instead of Budget
Decisions
Budgets typically run on continuing
resolutions: agreements to allow agencies to
spend at the rate of the previous year’s
budget
Overlapping Committee Authority:
requires the executive branch to defend
the same section of the president’s budget
before several committees in both House
and the Senate
7
Problems with the Federal Budget Process
Lengthy budget process
Uncontrollable budget items
No separate capital budget
Overly detailed budget
8
Possible Budget Reforms
The annual budget could be converted
into a two-year budget, or biennial
budget.
Simplify the budget document by
concentrating only on major groupings
and eliminating line items
Sort federal spending into an operating
budget and a capital budget
9
Fiscal Impact of the Federal Budget
When government outlays—purchases
plus transfer payments—exceed
government revenue, the result is a
budget deficit
Deficit financing has been justified for
outlays that increase the economy’s
productivity— capital outlays for
investments
10
Budget Philosophies and Deficits
Annually balanced budget: budget philosophy
prior to the Great Depression aimed at
matching annual revenues with outlays, except
during times of war
Cyclically balanced budget: budget philosophy
calling for budget deficits during recessions to
be financed by budget surpluses during
expansions
Functional finance: budget philosophy using
fiscal policy to achieve the economy’s potential
GDP, rather than balancing budgets either
annually or over the business cycle
11
Exhibit 2: After Decades of Budget Deficits, Surpluses
Appeared from 1998 to 2001, But Deficits Are Back
Surplus
Deficit
12
Why Have Deficits Persisted?
One widely accepted model of the public
sector assumes that elected officials try to
maximize their political support, including
votes and campaign contributions
Voters like public spending programs but
hate paying taxes, so spending programs
win support and taxes lose it
13
Crowding Out
Crowding out: The displacement of
interest-sensitive private investment
that occurs when higher government
deficits drive up interest rates
An
increase in the deficit or a decrease in the
surplus reduces the supply of national savings
Higher interest rates crowd out some private
investment, thereby reducing the stimulating
effect of the government’s deficit
14
Crowding In
Crowding in: The potential for
government spending to stimulate private
investment in an otherwise dead economy
An
important determinant of investment is
business expectations and government
stimulus may improve expectations so firms
more willing to invest
15
Budget Surplus
In the early 1990s, outlays started to
decline relative to GDP, while revenues
increased: deficit declined and, by 1998,
created a budget surplus
What turned a hefty deficit into a surplus,
and why has the surplus slipped lately?
Tax increases in the 1990s
Vigorous recovery during the 1990s
Slower growth in federal outlays
Reversal in 2001
16
Exhibit 3: During the 1990s, Federal Outlays Declined
Relative to GDP and Revenues Increased, Turning
Deficits into Surpluses, But Not For Long
17
Exhibit 4: Government Outlays as a Percentage of
GDP Declined Between 1994 and 2004 in Major
Economies Except Japan
18
National Debt
The national debt is a stock variable
measuring the net accumulation of past
deficits, the total amount owed by the
federal government
Changes over time
U.S. debt levels compared to those in other
countries
Interest on the debt
Prospect of paying off the debt
19
National Debt
Distinction between the gross debt and
the debt held by the public
Gross debt includes U.S. Treasury securities
purchased by various federal agencies: debt
owed to the government itself
Debt held by the public includes debt held
by households, firms, banks, and foreign
entities
20
Exhibit 5: Federal Debt Held by the Public as Percent
of GDP Was Slightly Lower in 2004 Than in 1940
21
Exhibit 6: Relative to GDP, U.S. Net Public Debt in
2004 Was About Average for Major Economies
22
Interest on the National Debt
Because most federal securities are short term,
the national debt “turns over” rapidly
Nearly half the debt is refinanced every year –
debt service payments are quite sensitive to
movements in the interest rate
Interest payments peaked at 15.4% of outlays
in 1996 and have declined to only 6.7% of the
federal budget by 2004
23
Exhibit 7: Interest Payments of Federal Debt Held by the
Public as a Percentage of Federal Outlays Peaked in 1996
24
We Owe It To Ourselves
It is often argued that the debt is not a burden
to future generations because – although they
must service the debt, those same generations
receive the debt service payments
It’s true that if U.S. citizens forgo present
consumption to buy bonds, they or their heirs
will receive the interest payments – debt service
payments stay in the country
25
Foreign Ownership of Debt
The “we owe it to ourselves” argument does not
apply to the portion of the national debt
purchased by foreigners
Foreigners who buy U.S. government bonds forgo
present consumption and are paid back in the
future
Reliance on foreigners increases the burden of the
debt on future generations because future debt
service payments no longer remain in the country
26
Crowding Out and Capital Formation
Government borrowing can drive up interest
rates and crowd out some private investment
by making it more costly
The long-run effect of deficit spending depends
on how the government spends the borrowed
funds
If
they are used in public investments there may be
no harmful effects on the economy’s long-run
productive capabilities
If they go toward current consumption, less capital
formation will result
27
Crowding Out and Capital Formation
With less investment today, there will be
a smaller endowment of capital
equipment and technology
Despite the large federal deficits of the
1980s and early 1990s, public investments
in capital declined
28