Budget Deficits and the National Debt Definitions Actual and Structural Deficits Burdens of the National Debt

Definitions Budget Deficit (BD) is the amount of borrowing by the Federal government in a given year = Government Purchases – Net Taxes = G – T ($400 billion for 2005)  The National Debt is the total stock of outstanding debt owed by the Federal government. (about $8.3 trillion)

Federal Government Tax Revenues

Federal Government Spending

The Federal Budget

FIGURE 4: Official Fiscal-Year Budget Deficits, Copyright © 2006 South-Western/Thomson Learning. All rights reserved. Fiscal Year Federal Budget Deficit 0 –100 –150 –200 –300 –250 –400 – – $400 ’00’01 ’02 3’04 ’ ’ ’97 ’98’99 Deficits Surpluses

Actual and Structural BD Question: What determines the size of the BD? Total taxes (T) can be expressed as T=T 0 +tY (lump-sum taxes)(variable income taxes)  Factors which affect BD: (1)Government purchases (G): G  BD (2)Tax Policies (T 0,t): T 0,t  BD (3)Real GDP (Y): Y  BD

Budget Deficits “naturally” rise during recessions and fall during economic expansions. Income taxes provide the economy with “automatic stabilizers.” Policy Debate: Is it a good idea for Congress to pass a “Balanced Budget Amendment?”

Budget Deficits and the Economy Expansionary fiscal policies  Y and can BD  What’s wrong with large BD? Seems to have positive effects on GDP.  Two negative “side-effects” of large BD. (1)Higher interest rates and crowding-out of private investment (Short & Long Run). (2)Large National Debt (Long-Run).

Burdens of the National Debt Popular argument: “Budget deficits are bad because they place a burden on our future generations who will have to pay it off.” (every man, woman, and child owes $27,000) National Debt Clock:

The Federal Government Debt

FIGURE 3: The U.S. National Debt Relative to GDP, Copyright © 2006 South-Western/Thomson Learning. All rights reserved. Ratio of Public Debt to Gross Domestic Product Ratio of Public Debt to Gross Domestic Product 0.33 Ratio of Public Debt to Gross Domestic Product Year World War I Great Depression World War II 1974–1975 Recession 1981–1984 Tax cuts 1981–1982 Recession Budget Agreement 2001–2003 Tax cuts 1915 Ratio of Public Debt to Gross Domestic Product

If the national debt is domestically owed, then “we owe it to ourselves”. Maybe wealth redistributions (winners and losers) True Burden of the National Debt (1)Taxes on debt owed to foreigners (not domestic). (2)Impact on Capital Formation and economic growth.

Summing Up - What Most Economists Believe? (1)Consequences of Choices Using Cost/Benefit Analysis (2) Look at the BIG picture! (3)Self-Interest is a Useful Principal in Understanding How Society Works (4)Incentives Matter (5)Opportunity Costs (6)Demand and Supply: Markets are Powerful Forces. (7)Benefits of Exchange and Specialization (8)Things Add up