1 Chapter 12 Budget Balance and Government Debt. 2 Budget Terms A Budget Surplus exists when Tax...

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Chapter 12

Budget Balance and Government Debt

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Budget Terms A Budget Surplus exists when Tax Revenues

are greater than expenditures and is the difference between the two.

A Budget Deficit exists when Expenditures are greater than Tax Revenues and is the difference between the two.

The National Debt is the sum of deficits minus the sum of surpluses since 1776.

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Figure 12.1 Federal Budget Deficits, and Surplus as a Percent of GDP, 1959-2002

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High-Employment Deficit or Surplus The budget balance is altered significantly by the

state of the economy.

If GDP is rising quickly, then fewer people are drawing on the welfare state and more are paying taxes.

The high-employment deficit or surplus is what the surplus would be if unemployment were low.

Economists often prefer this measure to the actual level of the deficit or surplus when advocating policy.

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Measuring Budget Balance On Budget vs Off Budget

Social Security and the Post Office are run off budget.

Since 1982 Social Security has run a considerable surplus.

This money is loaned to the rest of the on budget side of the government with the bonds issued to the Social Security Administration being the Social Security Trust Fund.

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Unified Budget The Unified Budget is the sum of the on- and

off-budget deficits and surpluses.

If this is a net deficit, then the government must borrow new money from the public.

If it is a net surplus, then it is a net provider of capital to the private sector.

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Figure 12.2 Government Demand for Loanable Funds and the Market Rate of Interest

Inte

res

t R

ate

Loanable Funds per Year 0

E'

L2

i2

D1 + DG

L1

i1 E

S

D1

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Ricardian Equivalence

Ricardian Equivalence is the view that deficits do not alter interest rates because citizens today see that deficits today will be financed with higher taxes tomorrow and citizens save in order to have the funds to pay those higher taxes.

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Figure 12.3 Ricardian Equivalence: Deficits Do Not Affect Interest Rates

Inte

res

t R

ate

0 L1

E'

L2

i2

i1

Loanable Funds per Year

D1 + DG

E

S

D1

L3

E''

L

S'

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Figure 12.4 Impact of a Budget Surplus on Credit Markets

D

E I1

L1

S

L

E' I2

L2

S' = S1 + L

Inte

rest

Ra

te

Loanable Funds per Year 0

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Budget Balance, National Saving, and Economic Growth

An increase in the deficit contributes to a decrease in national savings, while an increase in a surplus contributes to a increase in national savings.

Increases in national savings increase the potential for the economy to grow.

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Figure 12.5 The National Savings Rate and its Components, 1959-2002 (Ratio of Savings to GNP)

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Incidence of Deficit Finance Lower growth rates imply lower incomes for

future generations.

If Ricardian Equivalence holds, then this is not the case.

Deficits may also change political equilibrium so that there are increases in government infrastructure that could lead to increased future growth.

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The Government Debt

January 2003

Federal Debt $6.4 trillion

State and Local Debt $1 trillion

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Figure 12.6 Federal Debt Held by the Public as a Share of GDP (By fiscal year)

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Gross public Debt of the US Treasury by

Holder January 29, 2003 Holder Amount of

Debt (Billions of Dollars)

Percent of Total

U.S. Govt. AgenciesTrust Funds and Federal Reserve

2,769.0 43

Private Investors 3,630.3 67

Total 6,399.3 100.0

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Net Public Debt of the U.S. Treasury by Holder

(Percent Distribution) June 2002 Holder Percentage of

TotalDepositors and Institutions 7.2

Mutual Funds 8.8

Insurance Companies 3.9

Pension Funds 10.5

State and Local Governments 9.5

Foreign and International 37.6

Other Investors 22.5

Total 100.0

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State and Local Borrowing

Bonds are issued by state and local governments to fund large projects.

They are rated by financial companies for their risk.

Much of the debt is held externally. 

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General Obligation vs Revenue Bonds

General Obligation Bonds are backed by the state or local government’s ability to tax.

Revenue Bonds are backed by the revenue that a state or local enterprise would generate.

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Burden of the Debt Impact on future generations:

People have to pay increased taxes to pay interest on that debt.

Some may inherit the original bonds. Growth rates are reduced because of higher

interest rates.

These impacts can be offset by the increased private savings of the generation that does the borrowing, or by returns that come from programs that were funded by the borrowing.

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National Saving and Government Budget Balance

National saving in the United States remains low by international standards.

A compelling argument in favor of running a budget surplus is to help increase national saving to pay Social Security pensions in the 21st century.