Copyright © 2010 Pearson Addison-Wesley. All rights reserved. Chapter 14 Deficit Spending and The Public Debt

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Did You Know That... The U.S. federal government spends a total of more than $3 billion per day on Social Security, Medicare, and Medicaid. Each of these guaranteed spending programs is individually nearly as large as the entire discretionary portion of the federal government’s budget.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved 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) Government Budget Surplus –An excess of government revenues over government spending during a given period of time

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Public Deficits and Debts: Flows versus Stocks (cont'd) Public Debt –The total value of all outstanding federal government securities –Accumulation of deficits (minus surpluses) Time Squares Debt Clock 2008

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Figure 14-1 Federal Budget Deficits and Surpluses Since 1940 *Budgeted items not including 2008–2009 financial institutions bailout expenditures. Source: Office of Management and Budget.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Figure 14-2 The Federal Budget Deficit Expressed as a Percentage of GDP *Budgeted items not including 2008–2009 financial institutions bailout expenditures. Sources: Economic Report of the President; Economic Indicators, various issues.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved 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? Answer –Spending has increased at a faster page since the early 2000s than during any other decade since WWII. –Recent income, capital gains, and estate tax cuts

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Figure 14-3 Net U.S. Public Debt as a Percentage of GDP Source: U.S. Department of the Treasury.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Evaluating the Rising Public Debt (cont'd) 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.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Evaluating the Rising Public Debt (cont'd) 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.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Evaluating the Rising Public Debt (cont'd) 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.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Evaluating the Rising Public Debt (cont'd) Our debt to foreign residents –We do not owe all the debt to ourselves: about the nearly 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.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Evaluating the Rising Public Debt (cont'd) If deficits lead to slower growth rates 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

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Growing U.S. Government Deficits: Implications for U.S. Economic Performance (cont'd) In considering how expenditures might be reduced, it is important to look at entitlements. Entitlements –Guaranteed benefits under a government program such as Social Security, Medicare, or Medicaid –Noncontrollable

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Figure 14-5 Components of Federal Expenditures as Percentages of Total Federal Spending Source: Office of Management and Budget.

Copyright © 2010 Pearson Addison-Wesley. All rights reserved Myth #14: An irresponsible government has led to our current debt problem Review the last slide… Of course, there are wastes, but To kill the debt, you have to kill the entitlements