Chapter 14 Powerpoint

Chapter 14
Deficit Spending
and The Public
Debt

Copyright ©2014 Pearson Education, Inc. All rights reserved. 14-2
Introduction
In recent years, total expenditures of the federal
government have been considerably greater than
receipts. Every discretionary federal spending program
has been financed with borrowed funds.
Because federal discretionary spending has exceeded
$1 trillion per year, the federal government has had to
borrow more than $1 trillion per year.
In Chapter 14, you will contemplate the implications of
federal borrowing.

Learning Objectives
• Explain how federal government budget
deficits occur
• Define the public debt and understand
alternative measures of the public debt
• Evaluate circumstances under which the
public debt could be a burden to future
generations

Learning Objectives (cont'd)
• Analyze the macroeconomic effects of
government budget deficits
• Describe possible ways to reduce the
government budget deficit

Chapter Outline
• Public Deficits and Debts: Flows
versus Stocks
• Government Finance: Spending More than
Tax Collections
• Evaluating the Rising Public Debt
• Federal Budget Deficits in an Open
Economy
• Growing U.S. Government Deficits:
Implications for U.S. Economic Performance

Did You Know That ...
• Even though government projections indicated that
2020 would be the year in which tax collections to
fund Social Security would fall below beneficiary
payments, the actual year was 2011?
– The federal government is making up the difference by
allocating a portion of regular government spending
towards Social Security benefits.
– Yet, tax revenues are insufficient to cover all of the
government’s other expenditures.
– Consequently, current Social Security benefits are partially
funded with borrowings that must be repaid in future
years.

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)

Flows versus Stocks (cont'd)
• The federal deficit is a flow variable, one
defined for a specific period of time, usually
one year
• If spending equals receipts, the budget is
balanced
• If receipts exceed spending, the
government is running a budget surplus

• Balanced Budget
– A situation in which the government’s spending
is exactly equal to the total taxes and revenues
it collects during a given period of time

• Government Budget Surplus
– An excess of government revenues over
government spending during a given period of
time

• Public Debt
– A stock variable
– The total value of all outstanding federal
government securities

Government Finance: Spending More
than Tax Collections
• Since 1940, the U.S. federal government
has operated with a budget surplus in 13
years
• In all other years, the shortfall of tax
revenues below expenditures has been
financed with borrowing

Figure 14-1 Federal Budget Deficits
and Surpluses Since 1940
Source: Office of Management and Budget.

International Example: Cosmetic Enhancement of
the U.S. Deficits and Debts?
• The official government deficit and net
public debt may be huge, but the reality is
even worse.
– U.S. reports typically only provide data on the
federal government’s annual budget deficit and
net public debt.
– The U.S. federal government’s budget deficit per
year is about 8.5 percent of annual GDP.
– If state and municipal budgets were included,
the figure for total indebtedness would rise to
10.5 percent of annual GDP

Figure 14-2 The Federal Budget Deficit
Expressed as a Percentage of GDP
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 of more than 8% of GDP?
• Answer
– Spending has increased at a faster page since the
early 2000s
– Tax rates were reduced towards the end of the
recession

Evaluating the Rising Public Debt
• Gross Public Debt
– All federal government debt irrespective of who
owns it
• Net Public Debt
– Gross public debt minus all government
interagency borrowing

Evaluating the Rising
Public Debt (cont'd)
• Some government bonds are held by
government agencies
– In this case, the funds are owed from
one branch of the federal government
to another
– To arrive at the net public debt, we subtract
interagency borrowings from the gross public
debt

• 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

Evaluating the Rising Public Debt (cont’d)
• During World War II, the net public debt
grew dramatically
• After the war
– It fell until the 1970s
– Started rising in the 1980s
– Declined once more in the 1990s
– And recently has been increasing again

Table 14-1 The Federal Deficit, Our Public Debt, and
the Interest We Pay on It

Figure 14-3 The Official Net U.S. Public
Debt as a Percentage of GDP
Source: U.S. Department of the Treasury.

• 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

• As more of the public debt is held by
foreigners, the amount of interest to be
paid outside the United States increases
• Foreign residents, businesses and
governments hold more than 50% of the
net public debt
• Thus, we do not owe the debt just
to ourselves

• 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

• 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

• Paying off the public debt in the future
– If the debt becomes larger, each person’s share
would increase
– Taxes would be levied, and may not be assessed
equally
– A special tax could be levied based on a person’s
ability to pay

• Our debt to foreign residents
– We do not owe all the debt to ourselves—what
about the more than 50% owned by foreign
residents?
– Future U.S. residents will be taxed to repay
principal and interest
– Portions of U.S. incomes will be transferred
abroad

• If deficits lead to slower growth rates, then
future generations will be poorer
• Both present and future generations will be
economically better off if
– Government expenditures are really investments
– The rate of return on such public investments
exceeds the interest rate paid on the bonds

Federal Budget Deficits
in an Open Economy
• Question
– Is there a relationship between the U.S. trade
deficit and the federal government budget
deficit?

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

Figure 14-4 The Related U.S. Deficits
Sources: Economic Report of the President; Economic Indicators, various issues; author’s estimates.

• As the government borrows funds to
finance the deficit, and domestic private
consumption does not decrease, then some
of these funds will be borrowed from
foreigners
• The interest rate paid on bonds will need to
be high enough to attract foreign investors

• 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
• How do higher deficits affect the economy
in the short run?
– If the economy is below full-employment, the
deficit can close the recessionary gap
– If the economy is already at full-employment,
the deficit can create an inflationary gap

for U.S. Economic Performance (cont’d)
• What are the long run macroeconomic
effects of higher budget deficits?
– In the long run, higher government budget
deficits have no effect on equilibrium real GDP
per year
– Ultimately, therefore, government spending in
excess of government receipts simply
redistributes a larger share of real GDP per year
to government-provided goods and services

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

What If … the government imposed a one-time
tax to pay off all the net public debt?
• The net public debt is about $12 trillion and rising,
while nominal GDP exceeds $15 trillion.
• Thus, if the government confiscated about three-
fourths of all income generated within one year,
it could repay the outstanding net public debt.
• To avoid creating more debt during that year,
however, the government would also have to
confiscate more than $3 trillion to fund its
continued spending.

What If … the government imposed a one-time
tax to pay off all the net public debt? (cont’d)
• Therefore, the government would have to
confiscate nearly all of one year’s income.
• In theory, this could be done, but only at the
expense of impoverishing the nation’s residents for
twelve months.

Policy Example: Could Higher Tax Rates
on “Millionaires’ Eliminate the Deficit?
• Is it possible to eliminate the federal deficit by
imposing a 100 percent income tax rate on people
earning more than $1 million per year?
• Figure 14-5 on the next slide shows the portion of
total income received by each income bracket.
• The sum of all income earned by those with annual
incomes of $1 million and up is less than $1 trillion.
• Therefore, even if the government were to
confiscate all of this income, it would not be
sufficient to cover the federal government deficit.

Figure 14-5 Distribution of Total Taxable
Income Based on Annual Taxpayer Earnings
Source: Internal Revenue Service.

• How could the government reduce all its red
ink?
– Increasing taxes for everyone
– Taxing only the rich
– Reducing expenditures
– Whittling away at entitlements

• 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

• Entitlements
– Guaranteed benefits under a government
program such as Social Security, Medicare, or
Medicaid
• Noncontrollable Expenditures
– Government spending that changes
automatically without action by Congress

Figure 14-6 Components of Federal Expenditures as
Percentages of Total Federal Spending
Source: Office of Management and Budget.

• 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

Policy Example: Federal Indebtedness is
Much Higher Than the Net Public Debt
• The U.S. government’s official net public
debt has been ballooning in recent years,
but its actual indebtedness has increased
even more rapidly.
– Every year, Congress borrows to fund the on-
going operation of Social Security.
– Also, future benefits for Medicare and Medicaid
have been promised without being funded.
– Laurence Kotlikoff of Boston University has
calculated that unfunded promises represent a
total value of $200 trillion.

You Are There: A Long List of Ways to Cut the
Federal Budget Deficit
• Gene Dodaro, head of the Government Accountability Office
(GAO), issues a report listing separately funded programs
with ―duplicative‖ objectives.
• Among these are:
– 100 programs for highways and railroads
– 82 programs to improve teacher quality
– 80 programs to provide transportation for low-income people
– 80 programs to promote economic development
– 57 programs to help U.S. residents become more financially
literate
– 52 programs to promote entrepreneurship
– 47 programs to assist with job training

You Are There: A Long List of Ways to Cut the
Federal Budget Deficit (cont’d)
• Eliminating these programs would permit
the federal government to cut about $200
billion from the annual deficit.
• Dodaro makes the report to Congress and
leaves it up to these elected officials to
decide on the budget cuts.

Issues & Applications: Borrowing Total
Discretionary Spending – And More
• There are three causes of higher federal budget
deficits since 2008:
– Lower tax revenues
– Higher discretionary spending
– Greater entitlement expenditures
• Figure 14-7 on the next slide displays the
percentage of tax revenues available for
discretionary spending.
• When the share of federal tax revenues allocated
to discretionary spending is below zero, the
government borrows more than the amount of
discretionary spending.

Figure 14-7 The Percentage of Federal Tax Receipts
Allocated to Federal Discretionary Spending
Source: Congressional Budget Office.

Summary Discussion
of Learning Objectives
• Federal government budget deficits
– Whenever the flow of government expenditures
exceeds the flow of government revenues a
budget deficit occurs
• The public debt
– Total value of all government bonds outstanding
– The federal budget deficit is a flow, whereas
accumulated deficits are a stock, called the
public debt

Summary Discussion
of Learning Objectives (cont'd)
• How the public debt might prove a burden
to future generations
– Higher taxes will reduce private consumption
– Crowding out might reduce economic growth

Summary Discussion
• The macroeconomic effects of government
budget deficits
– Because higher government deficits are caused
by increased government spending or tax cuts,
they contribute to a short-run rise in total
planned expenditures and aggregate demand
– In the long run, increased deficits only
redistribute resources from the private sector
to the public sector

Summary Discussion
• Possible ways to reduce the government
budget deficit
– Increase taxes
– Reduce expenditures by revising the terms of
entitlement programs

Chapter 14 Powerpoint

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Chapter 14 Powerpoint