Deficits and the Debt November 28, 2017

Concepts What term describes each of the following? Revenues = expenditures Revenues > expenditures Revenues < expenditures Balanced budget Budget surplus Budget deficit

Surplus in late 2000 When Bill Clinton left office in 2001, the nation had a budget surplus of more than $200 billion. The 2000 election between Al Gore and George W. Bush was over what to do with the surplus. Gore wanted to shore up Social Security and Medicare, as well as invest in programs favored by Democrats. Bush favored a tax cut.

Bush Tax Cut Rates under Clinton Rates under Bush 15% 28% 31% 36% 39.6% 10% 15% 25% 28% 33% 35% Congress also cut the estate tax and taxes on dividends and investments. The Bush tax cuts expired at the end of 2012. Congress and the president agreed to keep the Bush rates in place for all but the top two brackets which reverted to 36 percent and 39.6 percent.

Taxes fall, spending increases The Bush administration soon found itself at war in Afghanistan. In 2003, the United States began another war in Iraq. The two wars together cost hundreds of billions of dollars.

More spending Congress expanded the Medicare program to include a prescription drug benefit at an annual cost of more than $100 billion a year. Congress also increased spending on education, agriculture, and other items. Adding a prescription drug benefit to Medicare was more expensive than the Patient Protection and Affordable Care Act and, unlike the latter, it was not paid for. Its cost was added to the deficit.

Why does the chart project rising expenditures later in the decade? The baby boomers are retiring and collecting benefits. Revenues fell during the first part of the G. W. Bush administration because of tax cuts. They fell during the last part because of the recession. Note: During recessions, expenditures rise, revenues fall. Why?

Why is the deficit projected to grow? What happened here? The retirement of the baby-boomers. 2016 deficit = $666 billion

National Debt The national debt is the accumulated borrowing of the government. In late 2017, the debt stood at @429 At trillion. What is the relationship between the annual budget deficit (surplus) and the national debt?

The deficit and the debt An annual deficit increases the national debt by the amount of the deficit. An annual surplus decreases the national debt by the amount of the surplus.

Who holds our debt? Federal accounts, such as Social Security trust funds Domestic borrowers, including banks, insurance companies, and pension funds Foreign borrowers, including the Chinese and Japanese

Who Holds the Debt?

Deficit Causes Deficits increase during wartime Deficits increase during recessions Deficits fall during economic booms Deficits rise or fall depending on policy decisions

Debt service The national government pays interest on debt that is owed to the public. In 2015, the government paid $229 billion in interest on the debt, 6.4 percent of expenditures. Interest expenditures are expected to rise. Why is interest expense expected to rise? The debt is growing and interest rates are likely to increase.

International Comparison Debt as pct. Of GDP.

Deficits are not always bad Economists generally agree that deficit spending is an appropriate government response to a recession. People thrown out of work during a recession reduce their spending and that causes others to lose their jobs as the economy spirals downward. Business reduces its spending as well because of the slowing economy. The government can help reverse the cycle by running a deficit.

Deficits as a problem The deficit becomes an economic crisis if and when investors decide that the U.S. government is no longer a safe place to invest their money. At some point, investors may demand substantially higher interest rates before they loan the U.S. government their money, dramatically increasing the cost of the debt to U.S. taxpayers. Average interest rates on U.S. treasury securities that mature in 10 years are less than 2 percent.

Global Bond Yields

Worst case In the worst possible scenario, Chinese, Japanese, and other foreign investors will tell U.S. officials that they will no longer loan the U.S. government money unless it dramatically increases taxes and cuts spending in order to reduce its deficit. Those steps would likely harm the U.S. economy.

Deficit Politics—Democratic Priorities Appear to be serious about the deficit and the debt while blaming Republicans for being inflexible Avoid spending cuts large enough to threaten economic recovery Increase spending on education, research, transportation, etc. to promote economic development and job growth Protect priority domestic programs—Social Security, Medicare, education, student loans, environment, transportation, etc. Raise revenue by closing tax loopholes that benefit business and the rich Reduce the deficit

Republican Priorities Appear to be serious about debt reduction while blaming Democrats for refusing to cut spending Oppose any and all tax increases including closing tax loopholes Cut capital gains taxes and corporate income taxes Cut most domestic spending (Medicaid, Food Stamps, transportation, education, medical research, etc.) Protect Medicare and Social Security for current and near retirees while reducing spending for future retirees Increase defense spending Reduce the deficit

Trump priorities Cut tax rates Repeal the inheritance tax Increase defense spending Protect Social Security and Meidcare

What You Have Learned What is the history of budget deficits? What is the difference between the deficit and the national debt? Why is deficit reduction hard to do?